However, many theories indicate that monetary policy in itself can affect the banks' setting of interest rates over and above the channel that goes via the interbank rate. One theory is that when interest rates are at a high level, the percentage of unreliable borrowers increases – borrowers who are aware that they will not be able to repay their loans and are therefore insensitive to high interest rates. To compensate for this, the banks can raise the interest rates on all loans more than is motivated by the monetary policy steered rates, or they can reduce the amount of credit they supply. Another theory suggests that borrowers' creditworthiness via their balance sheets is affected by changes in interest rates. The idea is that a company that has, for instance, a high level of debt, will be less creditworthy if the interest rate rises. Actually profitable investment projects may thus not get off the ground because the company applying for a loan for the project is already heavily in debt and therefore has to pay a high credit risk premium, or is refused a loan. Yet another theory indicates that a hike in the interest rate increases the banks' financing costs when the general public's deposits decline. A larger percentage of the financing thus has to be obtained in the bond market. The banks are also assumed in this case to have a motive to raise the interest rates more than the central bank does.
The Monetary Policy Committee has needed to provide monetary stimulus not only to contain the short-term economic weakness but, even more important, to reduce its longer-run costs – social and economic. But we cannot do that at the expense of price stability – or, more technically, of allowing medium-term inflation expectations to drift away from the target of 2%. Were the anchor to slip, our ability to support recovery would be undermined. It is sometimes suggested that independent central bankers are more averse to inflation than to periods of low growth and increased unemployment. I hope the past few years have demonstrated that, in fact, it is the credibility of the Bank of England’s commitment to price stability that enabled us to provide such exceptional monetary support to help the recovery. It is unimaginable that, prior to Bank independence in 1997, any government would have been able to hold the policy rate at effectively zero and make a further monetary injection of £ without inflationary expectations – and government financing costs – spiralling out of control. But credibility is not to be taken for granted. Even we cannot provide stimulus without limit, without a wary eye to inflation expectations. Nor has it been at all easy to judge just how much stimulus has been needed to secure recovery given the extraordinary uncertainties about what is going on in the real economy.