BOJ policy: Secular policy mix and an external factor

Ending deflation requires a coordinated monetary and fiscal reflation policy. While Japan does not have the luxury of policy flexibility on the fiscal side, a premature tightening of fiscal policy will likely be avoided under Prime Minister Abe's leadership. The recent announcement of the government's policy on fiscal reforms sent a clear message that this government will pursue fiscal reforms by economic growth as opposed to spending cuts or large tax increases. 

The BOJ will have to play a major role in assisting this government's growth-led fiscal reforms, and will have to remain easy; it will be subordinate to the fiscal authority - given the clear challenge on the fiscal side in Japan - when economic conditions appear to warrant tightening or a normalization of the reflationary policy stance.

China is in a secular economic slowdown amid deleveraging, which is a powerful external headwind to Japan that requires accommodative policy. While slower growth in China can benefit commodity-importing economies such as Japan and the U.S., it will certainly be negative for global export demand, particularly in Asia. 

China was already the third-largest importer for the world economy (after the U.S. and Euroland) 10 years ago, and has doubled its imports to US$1.8 trillion per year since then, making it near Euroland's level.