Within the housing market, the improvement is meager compared with precrisis levels of activity. New home sales are still 50% below the average rate over the past 40 years, and house prices in 10 cities monitored by the Case-Shiller Index are down 30% from their peak. After six years of declining home prices, almost 11 million families, or about 22% of mortgage borrowers, are still in negative equity, saddled with more debt than their homes are worth.

Elsewhere consumer spending remains restrained, with growth of personal consumption expenditure in the second quarter of 2012 increasing at just 1.5% annualized, down from 2.4% in the first quarter of 2012 and 2.0% in the fourth quarter of 2011. Private investment, which includes housing, has slowed sharply over the last three quarters from 33.9% annualized in the fourth quarter of 2011 to 6.1% and 3.0% in the first and second quarters of 2012, respectively. Worryingly, new orders for durable goods — a good predictor of capital spending in the economy — have stalled out during the current calendar year, and the ISM Purchasing Managers' Index, an indicator of the manufacturing sector's health, declined to 49.6 in August, suggesting the manufacturing side of the economy has lost momentum. This is confirmed by the Chicago Fed's National Activity Index, a broad composite of 85 indicators, which declined to -0.87 in August, implying that growth is significantly below trend.

The problem that has most concerned policymakers is the labor market, where unemployment has remained stubbornly high at 8.1%, the participation rate continues near its postcrisis trough and employment growth remains disappointingly weak. For example, additions to nonfarm payrolls have increased by only 94,000 per month over the three months from June through August, compared with monthly gains of 226,000 in the period from January through March. The fundamental problem here is that without stronger aggregate demand, employers are not likely to increase their hiring (or their spending on business investment), and entrepreneurs are less likely to set up new businesses. But stronger demand, in turn, requires various preconditions to be met — including restoration of consumer and bank balance sheets to health — and the policies adopted by the authorities have not yet succeeded in creating these conditions.

This is why the Fed's latest QE move to expand its asset purchases again, this time by buying mortgage-backed securities (MBS) on an open-ended basis, has not had as much effect as previous episodes of QE. While the FOMC meeting and Federal Reserve Chairman Ben Bernanke's speech at Jackson Hole, WY, on Sept. 13 had some effect on asset markets immediately afterward, those effects appear to have waned considerably. The longer-term impact of the new QE policy will depend primarily on whether the Fed is successful in strengthening the US economic recovery and its effect — if any — on inflation.

Frankly, the outcomes are still very uncertain. The balance sheets of banks are starting to heal, but shadow banks are still licking their wounds, and households are still heavily indebted. Moreover, subject to the election results and congressional negotiations over the fiscal cliff, the federal government's balance sheet is a long way from starting to show any improvement. A full recovery requires as a minimum that the balance sheets of both households and the financial sector should be well on the way to normal levels of leverage.

Yet the Fed appears to be hoping that consumers and businesses will be ready to start spending again in the very near future. In my opinion, the links in the chain between Fed purchases of US Treasuries or MBS and final spending on goods and services by consumers or business-investment spending by firms are too long and too tenuous for investors to place much confidence in the Fed's actions. In my view, the balance-sheet repair process in the US will take two or three more years to be completed. That, in turn, means the Fed's policies will take longer to restore the economy to faster growth and lower unemployment than either policymakers or investors are currently expecting.

Looking forward, I expect real GDP growth to average 2.2% in 2012 and only 2.0% in 2013 as a result of the fiscal cliff. This is well below the normal 3% to 4% that is typical of the early stages of a recovery. Nevertheless, the current economic upswing should be sustained. However, inflation should fall significantly in the remaining months of the year and into 2013, with headline consumer price index (CPI) inflation averaging 1.9% for 2012 as a whole.

There is no guarantee these outlooks will come to pass.

On Sept. 6, ECB President Mario Draghi, having boldly asserted in London in late July that he would do "whatever it takes" to rescue the euro, eventually persuaded all his colleagues on the Governing Council — except Jens Weidmann, the German Bundesbank president — to accept a new plan to conduct so-called Outright Monetary Transactions (OMT). Under this scheme, the ECB will buy sovereign bonds of troubled eurozone economies with up to three years maturity, with no explicit limits.

However, there were two important conditions attached. First, the countries concerned must apply to the European Financial Stability Facility/European Stability Mechanism (EFSF/ESM) rescue funds and be willing to enter supervised restructuring programs. This means that the ECB bond purchases will come into operation only if, for example, Spain or Italy applies for bailout assistance. In other words, it requires a difficult political decision by the nation's leaders, but it will mean that monetary accommodation comes only with agreement to adopt more stringent fiscal discipline.

Second, any injection of funds resulting from the bond purchases will be sterilized. In short, there would be no net new injection of liquidity. Yet with eurozone M3 (a measure of money supply) growth averaging barely 3% so far this year and bank lending across the eurozone now declining, the region desperately needs some easing in liquidity conditions. Euphoria alone will not prop up the asset markets.

Another important milestone was the decision of the German Constitutional Court in Karlsruhe to reject petitions to block the ESM, provided that:

• Germany's future contributions were limited to euro 190 billion, equal to Germany's 27.2% share of the total fund.
• Any future increase in the size of the rescue funds was subject to prior approval by the German legislature.

In the financial markets, Spanish 10-year government bond yields had reached a euro-era high of 7.75% on July 25 before Draghi's dramatic promise. Following his pledge, they fell below 6%, while Italian government bonds declined more than a percentage point toward 5%. Meantime, the euro has regained some of its previous losses against the US dollar. Equity markets have also gained substantially with the Spanish IBEX 35 Index and Italian FTSE MIB Index, each up 35% from their July 24 lows. However, by the end of September, these achievements were jeopardized by a renewed crisis in Spain.

While these developments were taking place in Frankfurt and in the financial markets, economic performance across the eurozone has been weakening. Real gross domestic product (GDP) growth for the zone declined by 0.2% in the second quarter — following 0.3% in the fourth quarter of 2011 and 0.0% in the first quarter of 2012 — effectively meaning that the euro area is in recession. Weakness in the periphery is starting to affect performance in the core.

Looking ahead, the euro area has a whole range of uncertainties to deal with:

• Will Spain's Prime Minister Mariano Rajoy trigger the ECB's aid-for-austerity deal?
• Can the unelected Prime Minister Mario Monti's fragile coalition remain in power in Italy?
• Can Prime Minister Antonis Samaras keep his three-part Greek coalition and his external benefactors on his side long enough to get the EU loans delayed since June to flow?

If Spain or Italy applies for assistance during the months ahead, Europe could find that its financial firewall is too small. Moreover, although the ECB's bond-buying may deal with the symptoms of the euro's ills, it cannot tackle the unsustainable level of debts, and it cannot avoid the need for individual economies to cut back without serious risk of deflation.

In addition, the next quarter will see the Spanish bank bailout plan announced in full after global management consultants Oliver Wyman have assessed the banks' portfolios. Moreover, provided that Spanish Prime Minister Rajoy agrees to a more comprehensive restructuring for Spain's economy, ECB bond purchases could start. Finally, the last tranche of funds for Greece left over from the June agreement should be paid out.

However, none of these actions will be sufficient to revive the fortunes of the eurozone on their own or collectively. The fundamental problem is that Europe's leaders are trying to overcome some basic flaws in the structure of the eurozone while simultaneously propping up several economies that have strayed far from the path of economic and fiscal discipline. For example, the protracted debates about the size and functions of the rescue funds or the size and scope of ECB bond purchases are an attempt to substitute the EFSF or ESM for a full fiscal union. If there were a full fiscal union, no rescue funds would be needed. On the monetary side, the currency union has become too big, encompassing economies that are at the same time too diverse in terms of their per capita incomes and productivity growth and too restricted in terms of their labor mobility and fiscal transfers. Without solutions to these fundamental problems, the asset bubbles and fiscal crises that developed in Spain, Portugal, Ireland and Greece could simply be repeated in the next cycle.

My forecast for the Eurozone is for growth to fall to -0.8% for 2012 as a whole, and inflation to be 2.2%, with a minimal recovery in 2013 and inflation falling further.

There is no guarantee these outlooks will come to pass.

None of these headwinds will be overcome quickly, but there are growing signs that nominal wages could exceed inflation in 2013, generating positive real consumer spending.

Given the high levels of outstanding debt among householders and the overriding need to restore stability to the banking sector policymakers can take only limited measures to accelerate balance-sheet repair. A review of the historical evidence on recoveries from past financial crises suggests that the time taken to achieve a full recovery depends on factors such as the extent of leverage at the onset of the crisis, where or in which sectors the leverage was concentrated, the national savings rate and the underlying growth rate. Unfortunately, Britain scores very poorly on all these measures, implying a prolonged and painful climb back to full economic health.

The repair of household and financial sector balance sheets is proceeding slowly. The debt-to-disposable income ratio of households has declined from a peak of 175% in the third quarter of 2008 to 146% in the second quarter of 2012, equivalent to the leverage ratio reached in 2004. Some economists have pointed out that financial assets of households have increased by an amount comparable to the growth of debt — implying zero increase in net debt — but this is simply the consequence of the buyers or borrowers paying the sellers for their assets. What matters is that, since house prices have declined and credit conditions have tightened, a substantial fraction of households have a debt level higher than desired and wish to reduce it. It is impossible to know how far households will wish to reduce their debt-to-income ratio, but based on the experience of the 1990s, this is likely to take the best part of a decade (as it did then).

With respect to the banks, they entered the crisis with leverage ratios in excess of 50 times (measured as unweighted assets to common equity), and that ratio has declined to about 33 times. For better or worse, Basel III — a global standard set by members of the Basel Committee on Banking Supervision to regulate bank capital adequacy, stress testing and market liquidity risk — is proposing a leverage ratio of 22 times (4.5% capital to risk assets, supplemented by an additional 2.5% capital buffer), and the Vickers Commission — the UK's Independent Commission on Banking chaired by Sir John Vickers — has proposed a leverage ratio of 10 times for large retail banks, so there is still a considerable way to go.

On the external side, the crisis in the eurozone (and the consequent recessions in the periphery and slowing growth in the core), the subpar growth of the US economy, and the slowdown in China and the rest of east Asia are all contributing to weak demand for British exports. Slower growth of Britain's exports than might otherwise be the case implies a longer period will be needed to rebalance the economy away from consumption and housing toward exports and business investment.

Probably the area where the authorities can make the most contribution is in overcoming the tendency over the past year or two for inflation to exceed personal income growth, which had the effect of eroding purchasing power in the crucial consumer sector. However, even here the solution is not straightforward. Promoting additional domestic spending by monetary or fiscal means may weaken sterling and encourage inflation; conversely, restraining domestic spending too much could weaken the recovery and delay private-sector rebalancing.

Inflation has slowed to 2.5% year-on-year in August and should decline further. The fact that Britain has suffered higher CPI inflation than either the US or the eurozone over the past two years reflects three factors:

• The surge in monetary growth in 2009 and 2010.
• The fiscal choice to raise indirect taxes such as value added tax, fuel duties and air passenger duties.
• The weakness of sterling.

However, now that monetary growth has slowed (as demand for loans has plummeted) and the fiscal accounts are gradually improving (albeit too slowly to meet the coalition's target of stabilizing the debt-to-GDP ratio by 2015 to 2016), there are better prospects of nominal incomes exceeding inflation in 2013. This, in turn, should promote real GDP growth. In this environment, the Monetary Policy Committee is likely to hold bank rate stable at 0.5%. Additional tranches of asset purchases are likely if either inflation falls below 2% (which I expect) or if monetary growth plunges again.

My forecast is for real GDP growth of -0.1% for 2012 as a whole and for recovery to modest positive growth of 1.5% in 2013. I expect inflation to average 2.6% in 2012 but to fall below 2% in 2013.

There is no guarantee these outlooks will come to pass.

Contrary to many other forecasters, I do not believe that a turnaround is imminent. It is true that:

• The National Development and Reform Commission has approved several large infrastructure projects in recent months.
• A number of local governments have announced measures to support industrial activity.
• The central authorities have launched a package of measures to boost exports, including faster payment of tax rebates and increased loans to exporters.

However, the big problem is that China has built a uniquely export-dependent economy in the past two or three decades, which also requires very high rates of growth of capital investment to support its exports. With any downturn, such as the present overseas slowdown, China's huge capital investments are vulnerable to a precipitate decline as capacity is curtailed. This is just the kind of problem that's facing China now.

China can clearly do very little to influence the external slowdown, but it is also severely hampered in its response to the immediate domestic downturn both by the transition to a new political leadership (a process that will be spread over several months from October to March) and by the recent memory of the adverse results of the 2008 to 2009 stimulus program — a property bubble and CPI inflation of 6.5%. Indeed, the leadership is still enforcing the administrative restrictions imposed in an effort to combat those unwelcome property price increases. Moreover, even though normal bank lending has largely been brought under control, lending to nonbank financial organizations, including property-related trust management products, is still rampant, growing at 31.5% year-on-year in the June quarter. It therefore makes no sense for the Chinese authorities to ease monetary conditions at present.

On a longer-term basis, China is transitioning from real GDP growth rates that averaged almost exactly 10% per annum in 2001 through 2010 to something more like 6% to 8% per annum. Such abrupt adjustments, as we have learned from Japan, are typically accompanied by significant disruptions. For 2012 as a whole, I now expect 7.5% real GDP growth (down from 8% that I forecast previously) and 2.9% CPI inflation. In 2013, I am forecasting 7.6% real GDP growth and inflation of 1.7%.

There is no guarantee these outlooks will come to pass.

Looking ahead, I expect the moderation in economic activity to continue, largely due to significant downside risks from a further slowdown in foreign demand and the escalating dispute with China over the Senkaku/Diaoyu islands. This is despite the BOJ taking more energetic steps to expand its balance sheet, most recently on Sept. 19, when the Policy Board decided to increase its asset purchase program from 70 trillion yen to 80 trillion yen, while maintaining its target for the overnight call rate at around 0% to 0.1%. It will "enhance monetary easing" by buying 10 trillion yen of Treasury discount bills and Japanese government bonds by the end of 2013. As usual, the BOJ Policy Board has opted for a cautious stance, despite acknowledging that "the pick-up in economic activity has come to a pause." To emphasize the timidity of Japanese monetary policy, it should be noted that M2+CD (a measure of the money supply used by the BOJ) growth was only 2.4% year-on-year in August, and the BOJ's balance sheet is still smaller than it was in 2006 when the Policy Board abandoned its last attempt at QE.

For 2012, I expect real GDP to attain 2.5% (mainly due to favorable base effects following the earthquake last year) but to slow to 1.4% in 2013. Japan's national CPI inflation decreased to -0.4% in July from -0.2% in June, while CPI inflation, excluding energy and unprocessed food, remained unchanged at -0.6%. Looking ahead, the loss of growth momentum and the strength of the yen should contribute to maintaining downward pressure on the price level. This means that the BOJ is unlikely to meet its target of raising CPI inflation to 1%. My forecast is for -0.1% this year and 0.1% in 2013.

There is no guarantee these outlooks will come to pass.

• Both economies are heavily industrialized and therefore their export performance is closely related to the strength of consumer demand in the developed economies of Europe and North America.
• Both economies have a large trade relationship with China.

In line with this external slowdown, foreign exchange reserve growth has plunged across the region, suggesting that monetary trends in Korea, Taiwan, Hong Kong and Singapore (the NICs, or newly industrialized countries) and Association of Southeast Asian Nations (ASEAN) will be on a softening trend in 2012 and 2013.

It is not only external demand that has weakened in Asia. Bank lending growth in Korea, Taiwan, Hong Kong and Singapore has halved — on average — from 18% year-on-year at the end of 2012 to below 9% in July. In ASEAN, it is a similar story. Similarly, real GDP growth in the Philippines, which had been enjoying strong growth, slowed from 6.3% year-on-year in the first quarter to 5.9% in the second quarter (and only +0.2% quarter-on-quarter). There has also been a significant slowing in India from an average of 7.5% in 2011 to 5.4% in the first half of 2012. The only exception in the region is Indonesia, where growth has remained stable at 6.4% over the past three quarters. Indonesia aside, this is all evidence of the heavy dependence of Asian economies on exports, and their vulnerability to global slowdowns, especially given their limited ability to generate domestic demand growth.

Inflation across the region is likely to slow from 5.5% in 2011 to 3.8% in 2012, benefiting from some softening of commodity prices but mainly due to weaker domestic demand and cooling property markets. Against this background, most of the central banks in the region kept their key policy rates unchanged during the quarter, but Korea and the Philippines both cut rates in the face of weakening activity, a trend that is likely to broaden during the period ahead as economic growth continues to slow. Despite the global slowdown, most of the Asian currencies have held firm against the US dollar during recent months, but there is limited upside from here onward. The September consensus forecast for Asia ex-Japan's real GDP in 2012 was 6.1% (revised down from 6.4% in June), and the inflation forecast was 3.8%. While the consensus is for both growth and inflation to increase slightly in 2013, my own view is that the slowdown will continue into 2013.

There is no guarantee these outlooks will come to pass.

My view is that this speculative surge is wrong for two reasons. First, there is an important clue to the direction of commodity prices in iron ore, which is much less subject tofinancial speculation than many actively traded commodities. Since July, the price of iron ore imports into both China and India has plunged, reflecting both the global slowdown in trade and weaker real domestic demand in Asia, as well as the excess of supply capacity in the industry.

Second, a fatal mistake in the speculators' logic suggests that the commodity rally is unsoundly based. The rally depends on the presumption that there will be a direct impact on inflation from central banks expanding their balance sheets. In reality, there can be no guarantee that faster growth of such "high-powered money" has any substantive implications for inflation unless commercial banks also pick up the baton and run with it by increasing loans or credit, and hence increasing or accelerating the growth of the broader money supply. With major sectors in the US, UK and the eurozone, such as households and financial institutions, still deleveraging, the banking multiplier is still broken, and therefore almost all of the central-bank balance sheet expansion will simply be matched by an increase in commercial bank reserves during 2012 and probably in 2013. This implies that commodity prices are likely to weaken rather than strengthen during the final quarter of the year.

There is no guarantee these outlooks will come to pass.