As the yen continues to trade too high for the well-being of the fragile domestic economy, the Bank of Japan will be inclined to try to do more, hoping that the government will make progress on stalled structural reforms. But rather than drive interest rates further below zero, which would be highly visible and unpopular, the central bank is likely to expand the use of its balance sheet to purchase financial assets.
The Bank of Japan remains in the business of buying time for the economy, but is doing so in an increasingly less certain fashion. Like its counterparts in Europe and the U.S., it hopes that a more forceful policy response by the government will eventually ease some of the excessive burden it has been carrying and save it from becoming woefully ineffective. Unfortunately, given the political situation, such hopes are likely to remain unfulfilled, amplifying the risk that central banks in the advanced world, starting with the Bank of Japan, could find themselves contributing to the economic malaise rather than easing it.
Mohamed El-Erian is chief economic advisor at Allianz SE.