A phase transition in monetary function explains expansion without inflation

TL;DR

This paper proposes that the impact of monetary expansion on inflation depends on a phase transition in monetary function, with recent shifts in Japan from cash to reserve dominance reducing inflation response.

Contribution

It introduces a phase-dependent framework for monetary function, identifying a transition in Japan that explains expansion without inflation through a measurable order parameter.

Findings

Japan experienced a shift from cash to reserve dominance after 2013.

Unexpected base money expansions are absorbed mainly as reserves, not consumption.

Inflation response is attenuated or reversed in reserve-dominated regimes.

Abstract

Large monetary expansions do not necessarily generate consumer-price inflation, challenging scalar views of "money supply." Here we propose that monetary function is phase-dependent: newly issued base money can occupy distinct functional compartments with different coupling to prices. Starting from an accounting framework that separates reproduction, consumption, and reservation, we operationalize a measurable order parameter, phi=RB/MB, the reserve-share fraction of the monetary base. Using Japan's monthly record (1971-2026), we identify a compositional phase transition after 2013 from a cash-dominated to a reserve-dominated regime, quantitatively captured by a Landau-type order-parameter transition. Phase-conditional local projections using unexpected (residual) base-growth shocks show that, in Japan, unexpected base expansions are absorbed primarily as reserve balances-phi rises significantly-rather than entering the consumption-goods transaction sector; consequently, the core CPI inflation response is strongly attenuated and can even reverse sign. This demonstrates that increases in monetary supply do not necessarily cause inflation: the key is the "phase" in which incremental money accumulates (reservoir versus circulation). We further define function-specific efficiencies for reservation absorption and CPI transmission and provide an operational distinction between circulation-driven and reservation-dominant inflation regimes.