It has not been about the reliability and security of commercial bank money as it has become more dominant in the economy. It is interesting to observe that in the eighteenth and nineteenth century there was a similar shift from state money, in the form of coins, to private money, in the form of banknotes, which in those days were bearer claims issued by private banks. That eventually generated a very different reaction, with the result that private banks in most countries were banned from issuing bank notes. 4  And I think that the lack a similar reaction to the increasing use of private money at the end of the last century was in principle the right one. Unlike in the nineteenth century, commercial banks operate under public regulation and with a guarantee of retail bank deposits.5 While banks create the bulk of money in the economy, the overall supply is controlled by the Bank of England through monetary policy. In such a framework, there is the necessary assurance, albeit indirect, about the robustness and reliability of commercial bank money: that is, of the claims we all hold on the banks that are licenced to take deposits and that provide our transactional bank accounts. I have said that this was the right reaction ‘in principle’. In practice, we discovered in the great financial crisis that the prudential controls on banks that took deposits and the deposit guarantee scheme were not strong enough.
It is equally important to avoid an inflation rate that is too low, as it is to avoid an inflation rate that is too high. BIS Review 74/2001  3  A change in interest rates is not expected to have an immediate effect on inflation. Our analyses 1 indicate that a substantial share of the effects of a change in interest rates will occur within two years. Two years is thus a reasonable time horizon for achieving the inflation target of 2½ per cent. Hence, the key rate is set with a view to achieving an inflation rate of 2½ per cent two years ahead. In some situations, where unexpected events lead to an inflation rate that is too high, it may be appropriate to apply a longer time horizon than two years. For example, reducing inflation to 2½ per cent within this time horizon may be associated with unnecessary real economic costs. A precondition for applying a longer time horizon is that there is clear evidence of strong confidence in low and stable inflation over time on the part of economic agents. Gradually, as we gain experience with setting interest rates according to an inflation target, the possibilities for placing emphasis on stability in the real economy will probably increase. Low and stable inflation is a necessary precondition for stability in the foreign exchange and financial market and the property market.