CANADA'S LONGWORTH SAYS BANK RATE PLEDGES MAY CAUSE INSTABILITY

Central bankers can create financial instability by giving investors too much confidence about the direction of interest rates, Bank of Canada Deputy Governor, Mr. David Longworth said.

'A central bank never in normal times wants to let people believe that there is next to no uncertainty about where rates are going,' Longworth, 58, said in an interview in Ottawa at the central bank's headquarters. 'The cost really ties into potential financial instability that comes if people think this statement about where interest rates are going is unconditional.'

Bloomberg reported on Thursday, that Canada made a conditional commitment on its key interest rate last April because the global credit crisis and recession created 'extraordinary' conditions, and the Federal Reserve has also promised to keep rates low for an 'extended period.'

Canada's pledge would not likely be extended, Longworth said today in an interview marking his retirement next week. The inflation targets set by central banks in Canada and countries proved helpful in dealing with the credit crunch, Longworth said, rejecting the idea that policy makers encouraged growth in asset prices, fomenting the crisis.

'In Canada, it didn't put any constraints on us that we didn't think were appropriate,' Longworth said. 'The use of inflation targeting by central banks actually helped us deal with the crisis.'

The focus of Canada's monetary policy for about two decades has been keeping inflation in check, with the bank saying this was the best contribution it can make to the economy.

No Canadian bank has collapsed during that time, unlike in the United States and Europe, and the Bank of Canada's key rate ranged between two per cent and four per cent for most of the last decade.

Creating new 'macroprudential' regulations that cover the stability of the entire financial system is a better way to prevent another financial crisis, rather than adjusting inflation targets, Longworth said.

Implementing the policies agreed to by leaders of the Group of 20 nations should 'minimize the way that monetary policy has to respond to financial stability questions,' Longworth said.

'That is one of the main issues that central banks are going to have to struggle with over the next two to three years.'

Longworth, the deputy governor in charge of monitoring the financial system, worked at the Bank of Canada for 36 years, starting as a researcher before becoming a deputy governor in 2003.

He said the worst moment in his career was 'the latter part of September and the early part of October in 2008 following Lehman,' he said, referring to the collapse of Lehman Brothers Holdings Inc. that threatened the global financial system.

The collapse hit banks worldwide, including in Canada, he said. Banks 'had some significant loses, some more than others, and we had to be following that,' Longworth said.