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Why a monetary union would have failed Quebec

In an earlier post, I noted that one of the casualties of the 2008 financial crisis -- and the ongoing euro zone crisis -- was the idea of a Canada-U.S. monetary union. But there's another monetary union project whose viability has been dealt a death-blow by recent events: that between an eventual independent Quebec and the rest of Canada (ROC).

An integral part of the 'Yes' platform in the 1995 secession referendum was the promise that an independent Quebec would continue to use the Canadian dollar. At the time, much of the debate on this point turned on whether or not the ROC could or would try to prevent Quebec from using its currency -- the answers were no, and almost certainly not.

If Quebec had seceded from Canada in 1995, it would have taken its own provincial debt (some $60-billion) plus its share of the federal debt: roughly 25 per cent of the federal debt (another $135-billion). This debt would have had to been carried by an economy with a GDP of some $177-billion. So an independent Quebec in 1995 would have had a debt ratio of about 110 per cent of GDP -- and this debt would have been denominated in the currency of another country. To put this in perspective, Greek debt in 2008 was also 110 per cent of GDP, also denominated in a currency it did not control.

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We know now that this is a recipe for a financial crisis of the first order. By adopting the Canadian dollar, the Quebec government would have deprived itself of the benefits of having a lender of last resort. In a pinch, the government of the ROC could always borrow from the Bank of Canada, but this privilege is only available to those governments that have their own currency.

An independent Quebec in 1995 would have still been obliged to borrow Canadian dollars in order to continue operations. Without a lender of last resort, potential lenders would almost certainly demand a higher interest rate, putting further pressure on Quebec's budget balance. A Greek-style meltdown would have been unavoidable, and there would have been no equivalent of the ECB or the EU to arrange a bailout.

The risks of forming a monetary union without a transfer union -- that is, without a mechanism for using taxes from one region to bail out another -- were well-known when the euro project began. Since then, we've learned that a transfer union is almost impossible to put into effect without a political union.

A Quebec-Canada monetary union would work only if there were a Quebec-Canada transfer union. And a Quebec-Canada transfer union would only work if there were a Quebec-Canada political union.

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About the Author

Stephen Gordon is a professor of economics at Laval University in Quebec City and a fellow of the Centre interuniversitaire sur le risque, les politiques économiques et l'emploi (CIRPÉE). He also maintains the economics blog Worthwhile Canadian Initiative. More

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