Japan's new prime minister, Shinzo Abe, has promised to force the Bank of Japan to change its monetary policy, and he seems likely to get his way. Though Abe's approach isn't risk-free, he is mostly right.

Critics see Abe's plan as a dangerous assault on the BOJ's independence. These fears are overblown. The more pressing issue is Japan's stagnant economy. Consumer prices have flatlined or fallen, which has held real interest rates above zero and made monetary policy too tight. Prices fell by 0.3 percent in 2011, were unchanged in 2012 and are expected by theInternational Monetary Fund to fall again in 2013.

Digging out of deflation isn't easy, but the U.S. Federal Reserve, the Bank of England and other central banks have shown that unorthodox measures can work even when interest rateshave been cut to nothing.

In principle, the Bank of Japan agrees. It has done some quantitative easing through its asset-purchase program and has kept interest rates near zero, but it has been timid in two main ways.

First, it bought mostly short-term securities. Because these are close substitutes for cash, issuing money to acquire them does little to ease monetary conditions. QE on a bigger scale and directed at longer-term securities, in the style of the Fed and the Bank of England, would be more effective.

Talking Down
Second, the BOJ has undermined its own modest efforts by talking them down. In monetary policy, "forward guidance" about the central bank's intentions is a powerful instrument in its own right. The Fed has put increasing stress on this, for instance by promising to keep monetary conditions loose even after growth picks up. The BOJ has usually done the opposite, which is tantamount to telling markets its efforts will fall short.

Last October, in an unusual joint statement with the government, the BOJ said it thought price stability in the medium term was consistent with inflation of 2 percent or less. Yet at the same time it affirmed an inflation goal of 1 percent "for the time being" -- then semi-retracted even this by announcing that easing would continue until the 1 percent goal was "in sight," not until it was achieved. This excess of caution is self-defeating.

Under mounting pressure from Abe and others, the BOJ announced new asset purchases in December and said it would review its medium-term price-stability goal at its next policy meeting later this month. Abe is calling for a 2 percent inflation target and threatening legislation. A new governor is due to be appointed in April in any event. One way or another, a long-overdue loosening of policy and a stronger commitment to see the new policy through look likely.

David Fuller's view Since the end of WWII when General Douglas MacArthur set the USD/JPY rate at ¥360 to $1, Japan has mostly had a disciplined monetary policy which supported a generally strong yen, as you can see from the historic chart above.

That was a generally good idea, at least until several years after Japan's stock market bubble and especially its enormous property bubble were intentionally and belatedly deflated in 1990. However, the continuing tightness of monetary policy in Japan tipped its economy into a long disinflationary cycle at considerably cost.

There were some beneficiaries but they were mainly older citizens who had become extremely wealthy during the 1980s boom. Following 1990, Japan's export led economy was slowly strangled by the yen's strength, as you can see from this historic chart of the Nikkei Index. Japan's problems were compounded by the stealth devaluations of its main competitors, not least the USA and emerging China.

Incredibly, the BoJ persisted with its deflationary policies and Japan's politicians did little about it, at least until Shinzo Abe's landslide election last month. He promised and immediately set about devaluing the overvalued yen as part of his economic recovery program. I maintain that he will help Japan's economy, not least after appointing the next Bank of Japan governor on April 1st.

(See also Eoin's recent reviews of Japanese shares see Comment of the Day on December 18th and November 15th.)