WAS the decision to raise a key tax this year a big mistake? For years, the political consensus has been that Japan's consumption (ie, value-added) tax needs to go up in order to control a ballooning public debt. In April the government of Shinzo Abe carried out a decision made by the previous government and lifted the tax from 5% to 8%. That is still low by developed-country standards, but it seems to have inflicted more pain than most predicted. Reports from Tokyo's brothel districts to the country's rural regions suggest the move has hurt an already limp recovery.

The last time politicians dared raise the consumption tax was back in 1997. It helped push a recovering economy back into recession. Then, however, the move coincided with a financial storm in Asia and a bad-loans crisis at home. This time, politicians seemed surer that people would soon head back to the shops. Yet the fall in household demand has proven even sharper than in 1997 (see chart), and a recession is again on the cards. The economy shrank by an annualised 7.1% in the second quarter of the year. Economists are growing nervous about Japan's third-quarter GDP, to be published on November 17th.

Europe is paying the price. The uncertainty has made it difficult for banks to raise funds, creating a severe shortage of credit in some regions. Since businesses cannot obtain loans to invest in equipment or hire people, growth is at a standstill and unemployment remains high.

The best way to create confidence "is to recognize loans that are bad and write them off, " said William White, the former economic adviser to the Bank for International Settlements, the bank for central banks. The risk in not doing so, he said, is a cycle of stagnation like in Japan.

Doubts, too, persist about whether the European Central Bank president, Mario Draghi, will make the bold moves necessary to revive the moribund economy and combat the deflationary trend. While he has unveiled an aggressive plan to buy bonds and pump money into the economy, details have been limited. That vacuum has only fed market concerns about the weakness in the global economy.

"You could argue the falloff of the eurozone economy is at the epicenter of this," said James W. Paulsen, chief investment strategist at Wells Fargo Asset Management. With the current weakness, investors will now be paying close attention to the verdict of the bank review. "Three or four weeks ago, no one in the US would have cared," he said.

Europe's new banking overseer, Danièle Nouy, has vowed that the ECB. bank tests will be tough.

The review is part of a broader effort to create a uniform system of regulation for Europe's biggest banks, replacing a country-by-country patchwork of supervision that the financial crisis exposed as woefully ineffective. The new pan-European regulator, the so-called Single Supervisory Mechanism that will officially take charge on Nov. 4, has the broad powers to curtail risky behavior and impose penalties.

The head of the group, Ms. Nouy, a lifelong civil servant steeped in esoteric banking rules, has been on a hiring spree, helping expand a small army of civil servants and outside consultants to scrutinize banks' books. An estimated 6,000 people are involved in the review.

Compared with previous efforts, the ECB is taking a more comprehensive look, sifting through about 135,000 loan files at 130 of the largest banks in the eurozone as well as Lithuania, which will become the 19th country in the currency union next year. That amounts to 85 percent of banks' outstanding loans and other assets, according to the ECB.

The banks will also undergo a so-called stress test to see if they could withstand a major recession, bond market panic or other adverse situation. The ECB. has deliberately kept some of the methodology secret, to prevent banks from trying to manipulate the results.

Investors "will know what is in the balance sheet of European banks," Ms. Nouy said in an interview. "I am totally confident about that."

The main goal is to expose so-called zombie banks, lenders that have covered up deep problems by issuing new credit to troubled borrowers rather than allowing them to default. Lenders in Italy, Greece and Portugal are under scrutiny, given the weakness in those countries. Banks with a heavy concentration in certain industries, like commercial real estate, also face pressure.

For example, HSH Nordbank, a lender in Hamburg, has been hit hard by huge loans it made to the depressed shipping industry. The bank's position is considered particularly perilous because its options are limited if the ECB. finds a capital shortfall. HSH does not have a stock market listing, so it cannot sell additional shares, a standard way to raise more money.

HSH Nordbank declined to comment. But a person with knowledge of the ECB. examination said the bank had enough capital to pass the asset quality review.

Pressure from ECB. auditors has already helped uncover grave problems at one bank, Banco Espírito Santo in Portugal, which collapsed in August in the face of fraud accusations. The specter of ECB. scrutiny has also prompted a scramble for new capital to provide bigger cushions against potential shocks. Banks including Deutsche Bank of Germany and Monte dei Paschi di Siena of Italy have raised 200 billion euros, or $256 billion, since last summer, according to an ECB. estimate.

To truly clean up the system, Ms. Nouy and the rest of the ECB. have to be willing to force some harsh medicine on the banks -- and come to a consensus on those decisions. That hasn't always been easy, at least based on Cypruss experience.

By 2013, the ECB. had approved more than EUR9 billion in loans made by the country's central bank to its second-largest financial institution, Cyprus Popular Bank. The money flowed to the institution, which later changed its name to Laiki Bank, despite objections by one top official who said it was insolvent, according to previously undisclosed minutes of meetings held by the ECB.'s decision-making arm.

For more What in the World watch Sundays at 10 am amp; 1 pm ET on CNN

By Global Public Square staff

The American economy is back. Last week, the IMF projected that the United States will be one of the very fastest growing advanced economies in the world in 2015. In fact, the American economy is just about the great exception in a world that is showing signs of economic stagnation.

Good news keeps piling on. The Congressional Budget Office just announced that the US deficit fell by nearly a third during the fiscal year, which marks a 6-year low. Meanwhile, the Dow Jones Industrial Average and the Samp;P 500 both surged to record highs over the last month. And the most recent economic snapshot from the Labor Department says that private sector employment grew in September for a 55th month in a row, a record, and that the unemployment rate is now at 5.9 percent, the lowest level it#039;s been since July 2008.

But, and here is the paradox, despite a relatively robust recovery now, Americans aren#039;t feeling more prosperous. In fact, 56 percent of Americans told the Pew Research Center in August that they are #034;#039;falling behind#039; financially.#034; That#039;s pretty much the same percentage as in October 2008, during the heat of the Wall Street financial crisis.

So, why are so many despondent over the economy when the statistics say it#039;s doing pretty well?

For some insight, listen to a recent interview that President Obama granted CBS News#039;s 60 Minutes:

Obama: Ronald Reagan used to ask the question, #034;Are you better off than you were four years ago?#034; In this case, are you better off than you were in six? And the answer is the country is definitely better off than we were when I came into office. But now we have to make sure...

Steve Kroft: Do you think people will feel that?

Obama: They don#039;t feel it. And the reason they don't feel is because incomes and wages are not going up.

Well, the President is right. The one number that isn#039;t up is the average American#039;s pay check.

Look at the data from The Economist, which in turn cites Census Bureau and Sentier Research data. They show that during the first six years of Ronald Reagan#039;s Presidency, the US economy grew by 22 percent and the median household income also shot up by 6 percent.

Fast forward to Bill Clinton#039;s first six years in the Oval Office and the nation#039;s GDP grew by 24 percent, while median income increased 11 percent.

Then, it starts to turn. The first six years of George W. Bush#039;s Presidency saw 16 percent GDP growth but a 2 percent decrease in median incomes. Likewise, the first six years of Obama#039;s presidency have seen 8 percent GDP growth coupled with a decline in median incomes - a 4 percent decline, again according to the research in The Economist.

Indeed, when you adjust for inflation, census data shows that the American middle class is actually 1 percent poorer today than it was in 1989, when Reagan left office. That#039;s also probably why Obama#039;s job approval rating is about 20 percent lower than Reagan#039;s was by the second October after his re-election, according to Gallup.

And guess what? The new employment report sees that trend continuing: the average hourly wage for Americans working in the private sector actually decreased by one penny last month.

Why are wages stagnating (or, even, falling)?

Nobody is actually sure. Generally, when unemployment drops, workers can demand better wages. That#039;s not happening. And no one quite knows why. It could be globalization, with its endless supply of cheaper labor from around the world. It could be technology, which replaces people with machines and software. It could be other, more technical factors.

But we think we can confidently say that until all this changes - and until the majority of Americans who do have jobs see some improvement in their wages - they will feel gloomy. And that will have economic consequences in the years ahead but also political consequences in the weeks ahead.

WASHINGTON (Reuters) - Global central bankers, eager to see the economy stand on its own feet, faced the rude reality this week of market turmoil threatening already faltering growth and prolonging world reliance on easy money.

Stocks slumped again on Wednesday pushing SP 500 losses to almost 8 percent since mid-September. The dollar fell and US bond prices soared after weak Chinese inflation and US producer price and retail sales data fanned fears the world economy could be even weaker than thought.

When stock markets turned south last week after rallying for much of this year, many policymakers initially played that down. In fact, the sell-off could be seen bringing some healthy volatility back to markets that officials worried had become too complacent to risks ranging from tensions surrounding the conflict in Ukraine to the Ebola outbreak.

But the deepening of the sell-off may have put major central banks on their heels, by raising the prospect of the market rout going too far too fast, threatening to hurt confidence and potentially triggering a pullback in spending.

It reminds me of the massive flight to quality we saw during the (2008) banking crisis, when there were fears that the whole global economy would tip into depression, said Nick Stamenkovic, a strategist at Edinburgh-based RIA Capital Markets.

Economists familiar with central bank policymaking say there is no doubt that officials are worried by the markets sharp turn for the worse. It is less clear how and when will they respond.

Over the past week investors have pushed back their expected date for an initial Fed rate increase from next summer to late in 2015 or even into 2016.

Ever since the financial crisis hit six years ago, central bankers have been at the forefront of a campaign to save the global economy, slashing rates to zero and pumping trillions of dollars into the world economy via unconventional policies such as buying vast amounts of government debt.

At meetings of the International Monetary Fund last week, central bankers appeared content that their mission was largely over and called on governments to do their part to boost demand and job growth by investing in infrastructure.


Central bank officials from Washington to Tokyo face questions that have dogged them in recent years: Is recent volatility just a sign of markets adjusting to a host of issues, from the potential for rising interest rates to tensions in the Middle East? Or is the world economy backsliding?

Those who still have wiggle room have already been using it with central banks in Sweden, Poland and South Korea cutting interest rates over the past few days. Beijing is also expected to use its policy leeway to keep rolling out stimulus measures to keep the worlds second-largest economy from cooling too much.

It is a greater challenge for the Fed, the Bank of England, the European Central Bank and the Bank of Japan, which have long hit the limits of conventional monetary policy.

Officials in Washington and London in particular were eager to start lifting interest rates in part because with rates near zero they have to resort back to unconventional policies to counter any new downturn.

San Francisco Federal Reserve President John Williams told Reuters on Tuesday that he would be open to another round of asset buying if the outlook for the economy worsened significantly. But he stressed it was a distant possibility and his main scenario was that the US economy would weather global headwinds and the Fed could start lifting rates in mid-2015.

The ECB and the BOJ, meanwhile, are still in the thick of unconventional policies that are achieving only mixed results. They may be hard pressed to do more, even though ECB President Mario Draghi recently suggested it was European nations turn now to do their part saying that European governments with the capacity to borrow, such as Germany, should ramp up spending.

The Feds policy setting committee meets Oct. 28-29 and plans to end its bond-buying program then. Its language will be watched particularly closely for evidence of how deeply recent world events have affected its thinking.

We have seen a lot of sizeable ups and downs in recent days and we dont know where the dust will settle, said Antulio Bomfim, a former Fed economist and senior managing director at the Macroeconomic Advisers consulting firm. I dont think this fundamentally moves the (Federal Open Market Committee) in a different direction, (but) it does throw more caution into a committee that was already cautious.

(This version of the story has been corrected to change dates of the next Fed policy setting committee meet in paragraph 16)

(Additional reporting by Paul Carrel in Frankfurt, David Milliken in London, Jonathan Spicer and Anna Yukhananov in Washington; Editing by Tomasz Janowski)