It depends on the audience. If you are going for accessibility, translate it. Basic English rules say that if foreign words can be easily translated, using the foreign word instead of an English term is incorrect. However, if you are writing for English-speaking anime/manga fans, you can get away with not translating it, as it then is a part of the jargon for that audience, akin to me using ethanol with chemists as opposed to alcohol with drinking buddies.
But then again, I lost this argument 15 years ago, when literal translation became the norm.
One does have to take into consideration the limits of accessibility, regardless of how easily a word can be translated. Think of the different types of German sausage - most have precise translations into English, but even amongst those not into German cuisine or language, they still use the German names. Anything ending in 'wurst' (Liverwurst, Blutwurst, etc.) tends to get this treatment, or more exotically, Braunschweiger. It means 'Brunswick sausage' (the 'er' implies the sausage in this case; Brunswick is the English name of Braunschweig the same way that Munich is the English name of M?nchen, or Bavaria<=>Bayern). Nobody uses the English name, though, and instead they use the German one (however badly they end up mispronouncing it in the process).
A good portion of it is simply how open to linguistic exchange one is. I personally deny the concept of 'literal' translations even existing at all because of the difficulties and nuances involved in translation. You can get close, but finding an absolutely exact equivalent of a word or phrase should be properly considered less common than it gets treated by those consuming foreign media (including the more obvious area of how it impacts religious texts). The further from English one gets, the less common 'literality' becomes, although that's still not an excuse for an overly-loose or sloppy translation. At some point a loanword is appropriate, whether because it describes the concept more accurately or because it matches the overall tone of the work.
The dispute in the anime/manga grouping is that to go into it expecting not to see Japanese culture, and therefore not encounter Japanese words or phrases, is a disservice - if not an insult - to the original media, as it would be with any bit of media that gets translated from one language to another. At its worst it leads to writing with invisible chalk and other culture bleaching that occurred in the old days of heavy censorship in localized anime. It goes back to the original point: accessibility is good if the series would naturally be successful, but how much is too much in the attempt to make the niche properties 'accessible'?
Now, as I don't speak Japanese, would someone like to explain why "monster" may/may not be a decent choice for youkai? Just to satisfy curiosity. Seems a better fit, or at least less loaded, than demon.
This is coming from my small absorption of Japanese, but it would be a much better fit, as the concept of a 'monster' being neutral is more acceptable than a 'demon' being neutral, but it tends to imply that the subject is still noticeably not human, and with youkai, some appear to be perfectly human until their more monstrous abilities or traits emerge. Not to mention that even if several of the species in Touhou are at least partially of the classical 'monster' archetype as Westerners would be familiar with (vampires, were-creatures, and what all...), most of them aren't.
The 'monster' translation tends to be applied to other Japanese words, though. 'Bakemono' is one which, like 'monster' does in English, also seems to cover the metaphorical usage when applied to ordinary humans perceived as acting inhuman. About the only subspecies that could have the 'demon' tag applied to them with a high amount of accuracy are the ones actually classified as Devils (whether that's Koakuma, the vampires, or both), or the oni (as oni are very frequently equated with demons in and out of the normal anime circles). The part there is that Westerners are already at least somewhat familiar with the word 'oni' in ways similar to the familiarity with terms from Greek or Norse mythology.
