Have you considered embracing the risk in fiscal policy by issuing fiscal stimulus packages with bank guarantees? I have some comments. The European Central Bank can go one way and the Fed can go another way. The Fed has long been a "paper tiger" but now it is real. And it appears to me that the Fed will continue to do very little until it gets caught.
I still believe the Fed will never risk its credibility on a long-run basis by raising rates unless there is a significant inflation surprise. But what if there is a significant inflation surprise that defies the Fed's inflation policy. Is risk management really that important? I would argue yes and no.
If the long term objective of central banks is to stabilize the interest rate through easing monetary transmission, then risk Premia should be considered in the equation. It appears that the Fed has been trying to accomplish this without the benefit of a forward outlook since early 2021. The last 6 months or so, they have tried to increase bank reserves (bills) and even to extend the balance sheet. All these efforts are accompanied by claims that inflation will rise above the central bank's 2 percent target over time. Are these measures enough to create a higher risk premium for long-term assets?
If such a premium was added to all long-term bonds, it would imply a valuation of U.S. Treasury Bonds of up to two percent above current market prices. To me this looks like a very large risk exposure that should be controlled. I don't see how anyone can legitimately add a risk premium of three to ten percentage points to short term U.S. Treasuries without creating a significant long term discount to yield. Risk premia of this magnitude should be regarded as a red flag for investors and institutions that are looking to obtain long term CDRs.
Some investors and institutions try to counter this argument by arguing that the Federal Reserve is simply taking advantage of the risk premium associated with long-term Treasuries. I think this argument is faulty in several different ways. First, I have never seen a published paper or article arguing that the Fed has been taking advantage of the risk premium and there are no documented cases of this. Second, I think the Federal Reserve could easily offset this increased risk by maintaining its purchases of Treasury debt at current interest rates.
The third argument is, "It costs money to raise interest rates." I think this argument has been seriously overstated and misleading. While it is true that the Fed would have to offset any extra risk by making its purchases of Treasury bonds, I don't believe this is a cost that warrants the high price tag that is often assigned to this activity.
The fourth argument revolves around the idea that Treasuries are a "good" risk. This argument assumes (and rightly so) that the current level of debt is already risk-free and that additional debt is not likely to result in additional risk. However, this is simply not the case. The historical evidence indicates that the long term interest rate on treasuries will tend to be higher than that of most other safe investments. Moreover, short term treasuries securities tend to have much higher default risk than do long-term Treasuries. While there is certainly nothing inherently risky about long term Treasuries, they are not a "safe" investment in my opinion.
The fifth argument relates to pricing and risk management. The flaw in this argument is that the pricing mechanism used by the Fed is not primarily risk management. Instead, it is price manipulation with the goal of controlling the market. It is my belief that the current excessive leverage taken by central banks worldwide is largely responsible for the current crisis. The use of too much leverage and interest rates were not caused by overly aggressive risk premia, but rather by ineffective risk management.