The world economy: Semi-rational exuberance A VIRUS is spreading through financial markets - and it isn't the flu. Investors around the world have been struck by a bout of optimism. As stockmarkets from New York to Tokyo hit multi-year highs, the VIX, a gauge of investors" fear, fell to its lowest since 2007. Is this ebullience justified? Up to a point. There are three reasons to feel more hopeful about the world economy. First, several disasters have been avoided. Europe's politicians have shown themselves determined to save the single currency. America's politicians avoided falling off the "fiscal cliff." And now that Republicans in the House of Representatives have offered to extend the debt ceiling for three months (see article), there is hope that America's fiscal battles will be waged by negotiation rather than blackmail. All this has boosted financial markets - and should encourage firms and consumers to invest and spend more. A second reason for cheer comes from central banks" activism. In September the European Central Bank promised unlimited bond-buying to keep the euro together. Then the Federal Reserve pledged to hold interest rates down until America's unemployment rate falls below 6.5%, along with open-ended monthly bond purchases. This week the Bank of Japan, under pressure from a new government, appeared to join the club of the bold. It doubled its inflation target, to 2%, promising to buy assets on an open-ended basis from 2014. With central banks pledging to buy more bonds for longer, which keeps their yields low, it is no surprise that investors are piling into riskier assets. Indeed, that's partly the point: higher share prices make investors more likely to boost consumption. Evidence that growth may be accelerating, at least in some places, provides the third reason for optimism. Much of the good news stems from China, where GDP growth jumped in the last three months of 2012, to 7.9% from 7.4% in the previous quarter. The latest figures, from retail sales (up 15.2% year-on-year in December) to industrial production (up 10.3%), have all been better than expected. The ebullient also point to America, where the housing-market recovery is gathering strength. Curb your enthusiasm These are all good reasons for feeling better about the world economy's prospects. But they need to be put into context. Politicians may have avoided catastrophes, but their policies are still flawed. America's cliff-avoiding tax deal, for instance, implies an immediate fiscal squeeze of 1-1.5% of GDP without any resolution of the country's long-term deficit. That tightening - much of which comes from a rise in payroll taxes on all workers - hasn't yet shown up in the data. But it soon may, and in an economy that has been growing at only 2% a year, the hit will be noticeable, perhaps more powerful than the boost from a healthier housing market. The prospect of central bank activism is not all it is cracked up to be. The fine print of the Bank of Japan's promises was much less bold than the headlines (see article). The European Central Bank's pledge to hold the single currency together does not extend to a willingness to loosen monetary policy further. And even at the Fed, worries about the unintended costs of unlimited bond-buying may grow. The biggest reason for caution, though, lies in the gap between financial-market optimism and economic reality. That gap is widest in Europe. The single currency may not be about to fracture, but its economies are still in deep trouble: the IMF expects the euro-zone economy to shrink by 0.2% this year. Those on the periphery are stuck in recessions. Even those in the core are looking weaker. With more fiscal austerity ahead and credit tight, it is hard to see how Europe returns to growth. The reforms needed to make the euro work are far from complete. America looks set to administer itself another dose of short-term austerity without addressing its long-term fiscal problems. Japan's economy needs deep changes. The latest bout of optimism in the markets is welcome, but governments should not let it infect them with a dangerous complacency.