The major problem with the Japanese economy and its deflationary phenomenon is not lack of government incentives, but lack of private domestic demand.

At a time when most of the developed economies have decided to stick to the fiscal policy measures and greater government intervention in the economy to boost the productive activity and pull the economy out of recession, Japan decided to deviate from this trend. At the outset, it must be borne well in mind that while many developed economies of the North America and the Europe seem to have overcome the worst of the latest recession cycle, Japan is yet to register sustainable and stable economic growth and overcome deflation. Moreover, the major problem with the Japanese economy and its deflationary phenomenon is not lack of government incentives, but lack of private domestic demand.

Following this, Japan opted for the more prudential use of various monetary policy tools to emerge out of the phase of economic depression and tame deflation. The share of public expenditure is already significantly large in the country, and it is not wise to expand the public sector further. Instead, measures can be taken to encourage domestic private demand through various monetary measures. Following this ideology, Bank of Japan decided to focus on keeping both long-term as well as short-term interest rates low and also to encourage private investment through allowing banks and financial institutions to undertake outright corporate financing in its recently announced monetary policy. This provides an interesting insight into how the neoclassical macroeconomic framework can be utilized to act as a panacea for the perennially decreasing price level and low levels of economic activity, rather than the traditional Keynesian remedy of increasing public expenditure.

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