The Calming Effect of Central Banks

EUROPE is hitting another rough patch. But this time, the troubles have barely rattled world financial markets. That’s a huge change.

Even though events in the United States precipitated some of the most acute stages of the 2007-8 financial crisis — the Lehman Brothers collapse is a prime example — the crisis in Europe has been the fulcrum on which world markets have pivoted over the last couple of years.

“We’ve seen world markets trade in unison to an astonishing degree,” said Stacy Williams, an HSBC strategist in London, in a telephone conversation last week. “Worries about the risk of a meltdown in Europe have been the main factor in the risk-on, risk-off phenomenon.” Global markets are tightly synchronized, he said, and they are still moving up and down primarily in reaction to short-term risk assessments.

For the moment, however, they haven’t responded dramatically to events in Europe, one way or another. It’s as if traders can’t decide whether to add to their bets or head for the exits. For now, at least, markets are moving sideways. 

It’s not as if the European economy is suddenly flourishing. To the contrary. Government statistics released in London last week, for example, suggested that Britain’s fiscal austerity program has helped to plunge that country back into recession. While there are pockets of prosperity, the economy of the European Union as a whole contracted in the fourth quarter of 2011, according to Eurostat. Many forecasters believe that a recession in the region is under way.

Economic pain and fiscal austerity led to the fall of the Dutch government last week, and are threatening the chances of Nicolas Sarkozy, the French president, in next weekend’s runoff against François Hollande, the Socialist candidate. Sovereign bond yields in Spain, which finds itself at the heart of the euro zone crisis, are testing the 6 percent level, a sure sign of serious trouble. Bailouts are already under way in Greece, Ireland and Portugal, while Italy remains in a precarious state.

But how have world markets reacted to all this? With a sigh and a collective shrug. Stocks rose last week in London, Paris and Frankfurt, and with the help of reassuring comments from the Federal Reserve, they did in New York as well.

Larry Kantor, head of research for Barclays, said the European Central Bank is largely responsible for the benign market response to Europe’s latest troubles. Through March, he said, the central bank has injected 1.153 trillion euros, approximately $1.52 trillion, into the European banking system, and much of that money has been used to buy sovereign debt, driving down yields and reducing some pressure on embattled governments and on the region’s broader economy.

“In November there was the risk of a real credit freeze,” Mr. Kantor said. Lack of bank lending actually “tipped the euro area into recession,” he said. “The injection by the E.C.B. was very important, and it really takes a lot of that disaster scenario off the table.”

He said that Europe would be struggling to resolve its financial problems for years, but that the “pragmatic” approach of the European Central Bank under its new president, Mario Draghi, has given the markets much comfort.

“For the short term, at least,” he said, “much of the tail risk has been removed.”

NONE of which is to minimize the fundamental challenges ahead for Europe, where frictions are mounting over the wisdom of the prevailing orthodoxy of fiscal austerity aimed at bringing down government debt loads.

In France, Mr. Hollande favors including a more Keynesian solution, involving government stimulus aimed at promoting growth and government revenue. Mr. Draghi, who has been firmly in the austerity camp, last week shifted his rhetoric modestly, calling for a “growth compact” in parallel with the European Union’s fiscal treaty, which limits budget deficits and national debt.

“We need to actively step up our reflections about the longer-term vision for Europe as we have done in the past at other defining moments in the history of our union,” Mr. Draghi told members of the European Parliament in Brussels. But he made it clear that he envisioned “structural reforms” intended to make European economies more competitive, rather than greater government spending. That is an approach that Angela Merkel, the German chancellor, also favors.

The United States faces similar issues, of course, but its economy, while hardly robust, is now growing more rapidly than most of Europe’s. Gross domestic product rose at an annual rate of 2.2 percent in the first quarter, according to Commerce Department figures released on Friday. That’s less than Wall Street had expected.

The economy is weak enough that Fed policy makers on Wednesday reiterated their commitment to hold short-term interest rates, now near zero, at “exceptionally low levels” for an extended period. They didn’t embark on any new unorthodox programs to stimulate the economy, but according to Barclays calculations, the Fed’s various quantitative easing efforts expanded its balance sheet by $2.35 trillion.

These balance-sheet operations, on top of the rock-bottom interest rates, have had an extremely stimulative effect, amounting to the theoretical equivalent of a Fed benchmark interest rate of approximately negative 4 percent, according to Thomas Lam, an economist at the OSK-DMG Group in Singapore.

Clearly, Fed policy makers remain on high alert, although their assessment of the domestic economy was slightly more upbeat than their previous forecast, in January. On average, they predicted last week that G.D.P. would grow 2.65 percent in 2012, an increase of 0.2 percentage point from their January estimate. The inflation rate will remain under the Fed’s target of 2 percent for the year, they estimated, and the unemployment rate will drop slightly, to 7.9 percent from its current 8.2 percent, according to Fed figures compiled by UBS Investment Research.

In a news conference on Wednesday, Ben S. Bernanke, the Fed chairman, said the central bank “will not hesitate” to take further action as needed to support the economy. Mr. Kantor said the markets might view that promise as “a kind of extension of the Bernanke put” — a guarantee of intervention should data deteriorate sharply — which should give traders some solace.

With election campaigns under way in the United States as well as in Europe, major new economic initiatives are unlikely for now, whether they amount to fiscal austerity or fiscal stimulus. If the markets remain calm in the interim, it may be mainly thanks to the influence of the central banks.