For Japanese business people and policymakers, the biggest question of this year is whether Japan's economy will be able to rid itself of deflation. Asking the question itself is right. The problem is that many continue to overestimate the impact of deflation, real or perceived. The result is a gridlock in policymaking. It's as if the nation's monetary and fiscal authorities are plagued by a deflationary trauma.

This gridlock stems from a policy of "quantitative monetary easing" that the Bank of Japan introduced in March 2001. At that time, the economy was suffering from serious credit shortages as financial institutions nationwide, including big banks, were struggling to sort out a massive level of nonperforming loans. Prices were continuing to fall, and economic growth was marking time. With interest rates already near zero, the central bank adopted a more direct policy of relaxing the monetary faucet.

That policy had two aims: getting rid of deflation and writing off bad loans. The second aim -- "final disposal" of loans gone sour -- was achieved at the end of March 2005, as the Bank of Japan continued to pump money freely into the banking sector under the "zero-interest-rate" policy. With volumes of bad debt returning to normal levels, particularly at major lenders, the specter of financial crisis had disappeared.