The use of unconventional monetary policy measures such as quantitative easing involves risk and uncertainty, but the extent of such risks has been greatly exaggerated, Bank of Canada Deputy Governor John Murray said on Tuesday.

Speaking to the Global Interdependence Center in Philadelphia, Pennsylvania, Murray discussed the use of unconventional monetary policy measures, including quantitative easing, credit easing, and conditional statements about the future path of policy rates. Several countries have implemented these measures in response to the economic downturn.

Murray admitted that the policies are often considered highly risky, with some observers believing they will be ineffective and result in a deflationary spiral, and others worrying that they will be too effective, leading to widespread inflation. But these concerns have been blown out of proportion as a result of a great deal of confusion over exactly how the instruments work, Murray argued.

“The risks of either a deflationary collapse or an inflationary spiral have been greatly exaggerated,” he said. “Central banks will not forget to shut off the liquidity taps when additional stimulus is no longer required.”

Murray added that the measures are necessary to stimulate the economy once traditional monetary policy measures are no longer having the desired impact.

“The unprecedented economic times in which we live and work have forced us to be increasingly creative,” he said. “There is good reason to believe that if these measures are implemented vigorously and with the clear support of authorities, they will be successful.”

The unconventional monetary policy measures taken by other countries have so far displayed positive results, Murray said. “The early results, along all three unconventional policy channels, are generally encouraging.”

Unconventional measures so far taken by the Bank of Canada include its explicit commitment regarding the future path of the target interest rate – a measure that is unusual in normal economic times. At its last fixed announcement date, the bank lowered the rate to 25 basis points and committed to keep it at that level until the end of the second quarter of 2010, conditional on the inflation outlook.

According to Murray, this measure has already proven to have a significant and lasting result, in the form of a 10- to-20-basis-point decline in implied yields on government bonds out to one year.

The Bank of Canada has not engaged in credit or quantitative easing, but it has launched credit-easing programs such as the Insured Mortgage Purchase Plan, Murray noted. In addition, in the bank’s Monetary Policy Report in April, it indicated that it would consider using both credit easing and quantitative easing to achieve its inflation objective.

In implementing any unconventional measures, the Bank of Canada will follow four guiding principles to limit the associated risk and uncertainty, the report notes. These include focusing on its 2% inflation target as its primary objective, considering the impact on economic conditions, minimizing the chances of distorting other markets, and acting prudently.

As part of its prudence principle, the bank will also ensure that any unconventional measures put in place can be reversed or undone without undue market disruption or threat to the central bank’s macro objectives, Murray explained.

“Extra care will be taken to achieve an orderly exit, guided by the clear monetary policy frameworks that most central banks now have in place,” he said.

IE