SELECT COMMITTEE ON ECONOMIC AFFAIRS - Parliament

Professor John Kay—Oral evidence (QQ 56–116)
liability for the debts of the Scottish Government. Then one could negotiate a significantly
looser fiscal arrangement.
Q82 Lord Forsyth of Drumlean: Is that realistic? It would be a bit like having the Royal
Bank of Scotland. Would a Scotland on our borders not be too big to fail? In practice, you
might have that agreement, but if the oil price halved, say, and they had gone off on some
spending spree and got into great difficulties, and they were using the pound, in practice
would we not be in a position where we could not see a neighbour using our currency fail?
Professor Kay: No, I do not think that that is right. If one goes back to the eurozone case–
that the eurozone problem would have been much less critical than it has become, and if
one accepted back in 2009, or, better still, it was made clear at a much earlier stage of
evolution of the European monetary system that there was no central guarantee of the debts
of individual countries—it is unlikely that spreads of interest rates within the eurozone
would ever have become as narrow as they did.
The Chairman: Can we do Lord Currie and then Lord Shipley and Lord Lawson?
Q83 Lord Currie of Marylebone: I am trying to understand how lender of last resort
functions would operate in this monetary union. The Bank of England has responsibility for
monetary policy. Would it have a limit of last resort role with respect to institutions in
Scotland? Given that the lender of last resort role tends to have a tax liability behind it,
where does that leave the fiscal arrangements between the two countries?
Professor Kay: I think that one has to unpick what lender of last resort means. When you
and I did courses in money and banking, not terribly recently—actually, these courses do not
exist anymore—“lender of last resort” was a concept told about the following story. It was
possible for a solvent bank to get into liquidity difficulties because there was a run on it from
depositors. In that case the central bank could halt the run by agreeing to take good
security from the bank in return for loans at a penal interest rate, with the expectation that
the run would be stopped and that the bank in question would be able to repay that. If
there were in Scotland a simple, boring bank of that traditional kind which got into
difficulties of that traditional kind, you do not even need a central bank to deal with that. A
Scottish Government guarantee of deposits would be enough to stop the run. Indeed, now
that we have deposit protection, that particular aspect of the lender of last resort role is not
important. The term “lender of last resort” now seems to be generalised to encompass
supportive operations for very complex banks whose main activities are trading and
wholesale money markets and which suffer from combined crises of both solvency and
liquidity, which are not capable of being disentangled.
For example, if Northern Rock had been a Scottish institution and the Northern Rock
problem had emerged essentially in isolation, a government or a local monetary institution
could have dealt with a problem of that kind perfectly well. Dealing with the Royal Bank of
Scotland is another matter altogether.
Q84 Lord Shipley: You said earlier that this could all be subject to negotiation but we are
discussing fundamental issues. Do you think that they should be clarified before a
referendum takes place so that people understand what they are, or can they be safely left
to post-referendum negotiation?
Professor Kay: I do not see how they could possibly be worked through in detail before a
referendum. I have a lot of sympathy with those who have said that if all this is to happen, it
must be a two-stage process. One stage is that you decide on the principle that you want to
164