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The Lucky Mallet is a special treasure that can change the size of whomever wields it. It can shrink them to a size so small that they can pass through "the eye of a needle."
When Amaterasu traveled to Ryoshima Coast, she aided the priestess Rao who believed that the curse plaguing Sei'an City could only be lifted with the power of the Fox Rods. According to Rao, the Fox Rods were located in the Sunken Ship off the coast. Amaterasu searched high and low but could find no trace of the Fox Rods in the ship's remains. She did however find the Lucky Mallet in the last room she explored. When Amaterasu left the ship, she was attacked by the Water Dragon. After retreating to dry land, the Lucky Mallet popped out and hopped away. Amaterasu chased the magical treasure all the way to the Imperial Palace, where she found a small hole where poisonous mist was leaking. The mallet shrunk her down to Issun's size, and allowed her to enter the Palace and explore it's grounds without worrying about being detected by the guards. After entering the Emperor's body and defeating the demon, Blight, the mallet restored Amaterasu to her true size.
The Lucky Mallet was used again when Amaterasu travelled to Ponc'tan, the village of the Poncles that resided in Yoshpet. The mallet shrunk Amaterasu once agin and allowed her to enter the village and learn about the Spirit Gate. The Lucky Mallet would shrink her whenever she returned to Ponc'tan.
The Lucky Mallet was found by Chibiterasu behind the Sage Shrine when he was traveling with Nanami. Nanami had control over the magical item and used to shrink Chibiterasu, much to his annoyance, and allow him to enter the Sage Shrine. She would later use it on both Chibiterasu and herself so that they could enter the Sage Shrine together. After exiting the Sage Shrine, Chibiterasu reunites with Kurow on the Goryeo. As they try to leave, the Lucky Mallet weighs the two down, not allowing them to fly away using Kurow's wings. The captain of the Goryeo offers to take the Lucky Mallet in safe keeping for them until they can retrieve. Shortly after handing the Lucky Mallet to the captain, the ship is attacked by the Water Dragon. Chibiterasu and Kurow flee as the ship is sunken by the Water Dragon, leaving the Lucky Mallet inside until Amaterasu and Issun eventually pick it up.
Spoilers end here.
Trivia
In Japanese legends, Issun-bōshi found the Mallet of Luck by defeating an oni, then use the item to enlarge him to normal size.
Despite being a mallet, the Lucky Mallet never actually hits anything. Instead it waggles twice over them, as if to hit them, and they shrink.