| NEW YORK
NEW YORK Feb 28 The market turbulence of last
year's "taper tantrum" is likely to return when the Federal
Reserve decides to raise interest rates, some top U.S.
economists concluded in a research paper that warns that more
policy stimulus today can spark bigger disruptions in the
The paper, published on Friday, focused on the May-June
taper tantrum, when then Fed Chairman Ben Bernanke's talk of
less stimulus sparked a market drop, as well as on this year's
sell-off in emerging markets. It argues that investors in mutual
funds, though unleveraged relative to more tightly regulated
banks, can destabilize things when they rush to sell.
The paper questioned whether the central bank was successful
in explaining to the public its true intentions in mid-2013, and
thus was able to stop any further bouts of selling, as some Fed
policymakers contend. It also suggested the economy faces bigger
risks the longer the Fed keeps rates near zero.
"Whenever the decision to tighten policy is made, then the
instability seen in summer of 2013 is likely to reappear. Hence,
risks of instability have not been eliminated," wrote JPMorgan
chief U.S. economist Michael Feroli, Anil Kashyap, a professor
at The University of Chicago Booth School of Business, both
former Fed officials, and two other well-respected economists.
They cited as supporting evidence the turbulence earlier
this year in the currencies and stocks of Turkey, Argentina and
other emerging economies, which also depressed U.S. equities.
And they noted that the Fed can be blamed regardless of whether
its actions in fact caused the market disruption.
The paper, also co-authored by Princeton University
professor Hyun Song Shin and Kermit Schoenholtz of New York
University, was presented at a high-profile economics conference
attended by Fed Governor Jeremy Stein, Chicago Fed President
Charles Evans, and other policymakers.
After more than five years of ultra-accommodative policies
in the wake of the recession, the Fed is taking the first steps
to wind them down. It modestly trimmed a bond-buying program in
each of the last two months, and it plans to raise rates some
time next year, as long as the economy continues to improve.
Interest rates have been near zero since the worst of the
financial crisis in late 2008; the Fed has meanwhile swollen its
balance sheet to more than $4 trillion in a further attempt to
stimulate investment, hiring and growth.
Fed policymakers are wary however that their stated plans
for future policy actions, known as forward guidance, can cause
borrowing costs to soar.
In May, after Bernanke told a congressional hearing that the
asset purchases could be tapered in "the next few meetings," the
yield on the 10-year U.S. Treasury bond jumped from 2.04 percent
to 2.54 percent over a month.
'NOT A FREE LUNCH'
The risk that all this easy money could bring about
financial instabilities has stoked debate within the Fed over
whether policymakers should stand ready to raise rates earlier
than planned to snuff out those risks.
Daniel Tarullo, a Fed governor and its top bank regulator,
said on Tuesday the central bank should not rule out using
monetary policy to combat asset price bubbles that potentially
threaten financial stability.
In the paper, the economists concluded that the current
policy stimulus "is not a free lunch" and can bring about
disruptions when that accommodation is lifted.
"Perhaps the domestic macroeconomic fallout from exit will
be as gentle as was the impact from the 2013 'taper tantrum,'"
they wrote. "However, such a benign outcome is not guaranteed:
while tapering is now under way, monetary policy remains highly
accommodative, so a meaningful exit has yet to occur."
Standing back, the economists argue that the Fed's two key
stimulus efforts, the bond buying and the forward guidance, "can
build future hazards by encouraging certain types of risk-taking
that are not easily reversed in a controlled manner."
The paper also underlines a concern that Tarullo and Stein
have raised in the past: that regulatory tools may not be enough
to stamp out risks in harder-to-detect corners of financial
The usual tools of monitoring banks - bank capital ratios
and liquidity requirements, among other regulations - fail to
address instabilities that mutual fund investors, for example,
can cause when they rush for the exits, the economists wrote.
The 55-page paper examined bond flows from mutual funds, and
noted that investors do not want to be the last out of a trade.
It finds that banks need not take action to spark market
tantrums, suggesting that too-big-to-fail banks should not be
the sole focus of regulators looking to stabilize markets.
The "absence of leverage may not be sufficient to ensure
that monetary policy can disregard concerns for financial
stability," the paper said.