Federal Reserve Gov. Daniel Tarullo said central bankers must preserve the option of using interest rates to lean against dangerous financial bubbles even as they strengthen supervisory tools to curtail systemic risk.

“Monetary policy action cannot be taken off the table as a response to the build-up of broad and sustained systemic risk,” Tarullo said Tuesday at a conference of the National Association for Business Economics in Arlington, Virginia.

An array of other tools, such as rules that would force banks to raise capital in times of overheating markets, could “reduce the number of occasions on which a difficult trade-off between financial stability considerations and near-term growth or price stability aims will need to be made,” he said.

A plunge in emerging-market stocks this year rekindled concerns about financial instability, with the MSCI Emerging Markets Index falling 8.6 percent through Feb. 5 before paring losses to 4.4 percent for the year as of Monday.

The Standard and Poor’s 500 Index briefly hit a record Monday before closing at 1,847.61 for a 0.6 percent increase. The S&P 500 Tuesday was little changed at 1,847.69 at 12:07 p.m. in New York. The benchmark for U.S. equities last year rose 30 percent in its biggest annual gain since 1997.

Tarullo said that Fed monitors have seen some evidence of increasing risk, while adding in a response to an audience question that U.S. central bankers should be concerned about their policy impact on emerging markets, which are “such a big part” of global growth and capital flows.

“High-yield corporate bond and leveraged loan funds, for instance, have seen strong inflows, reflecting greater investor appetite for risky corporate credits, while underwriting standards have deteriorated, raising the possibility of large losses going forward,” Tarullo said, noting that regulators issued guidance on the high-yield loans in March.

“Valuations do appear stretched for farmland, although recent data are suggesting some slowing, and for the equity prices of some small technology firms,” he said.

Tarullo said he has an “open mind” on whether the Fed should try to encourage lending by reducing the interest rate it pays banks on excess reserves.

“There’s been a good bit of back and forth on whether the rate should be lowered now, in an effort to push more lending out the door,” Tarullo said in response to an audience question. “I’ve got an open mind on that.” (Bloomberg)