Japan, the world's third largest economy, is taking bold measures to spur inflation and increase spending after a 15-year slump.

Bowing to demands from Prime Minister Shinzo Abe, the Bank of Japan (BoJ) announced on Thursday that it would reconfigure its policies to double the money supply, or the amount of funds in circulation, and achieve a 2 percent inflation target at the "earliest possible time".

Kozo Yamamoto, a senior lawmaker in Abe's Liberal Democratic Party, said: "The first step is to get out of deflation and get a much higher nominal growth rate."

A doubling of the money supply was needed to achieve that aim, he said.

The policies are a fundamental shift in how the central bank conducts monetary policy and appear a major concession to government demands, despite the bank's ostensible autonomy.

The bank' s new phase of monetary easing would, it said, "drastically change the expectations of markets and economic entities".

Tsuyoshi Ueno, economist at NLI Research Institute, described the moves as a huge regime change in monetary policy.

"What the BoJ announced today met almost all policy measures that had been speculated in the market," Ueno added.

Enter 'Abenomics'

Financial markets reacted with relief. The Japanese yen, which was trading at about 92.8 yen per US dollar, dropped to about 94.95 yen per dollar by mid-afternoon after the announcement on Thursday. 

The benchmark Nikkei 225 stock index rebounded from negative territory to close 2.2 percent higher.

Abe took office last year and his aggressive economic policies, designed to drag Japan out of deflation and boost demand, have been dubbed "Abenomics".

To further pick up the economy, the government has increased public spending to help lift demand, and has promised reforms to help make the economy more competitive in the long-run.

Whether these strategies can work will hinge on expectations of future inflation prompting consumers and companies to begin spending more money sooner to avoid rising prices, as Abe and his backers contend.

The past 15 years of deflationary stagnation, they say, is largely due to the tendency of consumers to hold back, waiting for prices to fall further.

Expectations of weak demand, especially given Japan's shrinking and aging population, discouraged corporate hiring and investment, pulling prices still lower.

Source: Agencies