<p>Update: the question was updated to make it clear that what is in mind is a foreign currency fund.</p>
<p>There seem to be two main reasons to build up a foreign currency reserve.</p>
<ol>
<li>A country has valuable natural resources (typically oil), and a reserve is built up to generate claims on the rest of the world for the time after the resource runs down, and to prevent the domestic currency from getting too strong (which damages the competitiveness of the non-resource industries). Similarly a country might keep its currency undervalued to support export-led growth, which requires building up reserves.</li>
<li>Build up reserves as a defensive measure, so that it is possible for domestic entities to import goods and service foreign debt. This strategy blends in with export-led growth strategies.</li>
</ol>
<p>The build up and run down of foreign currency assets is somewhat independent to domestic policy settings, as it a redirection of trade income flows.</p>
<p>For example, if the country spends its rainy day fund, it is presumably to import foreign goods. This means that the extra demand is being met from global productive capacity, and thus it likely has negligible inflationary effect on the domestic economy.</p>
<p>Building up the fund may also not be associated with reducing growth. If it is built up as part of an export-led strategy, growth may be higher (as was the case in Japan and China).</p>
<p>The rest of this answer discusses the issue of rainy day funds in a local currency.</p>
<p>A sub-sovereign does not issue the currency, but has obligations in the currency. It builds up a “rainy day” fund for the same reason an entity in the private sector does - to meet unexpected demands for cash. An increase in the rainy day fund acts as a form of saving, reducing aggregate demand. This will have a mildly deflationary effect. Unwinding the fund is mildly inflationary. This is true of any other entity in the economy that is not the central government, and in most cases, the effect of one sub-sovereign is not measurable.</p>
<p>However, sovereigns cannot really create “rainy day” funds in their own currency. They do keep balances at the central bank, which look like rainy day funds. But since the central bank is owned by the government, this deposit is a internal obligation of the consolidated entity - a debt the consolidated entity owns to itself. As such, the entry is largely cosmetic, and should have no measurable effect on the economy. (For example, such deposits disappear from standard macro models.)</p>
<p>Once again, a sovereign’s “rainy day fund” in its own currency is a debt it owes to itself. Any entity can create infinitely large debts to itself. For example, you can write an IOU to yourself for \$1 billion, and you have a \$1 billion in assets! However, this has not affected your net worth. Your net worth is what matters for economic outcomes, and thus such self-debt has no effect on anything.</p>
<p>About the only way for a central government to save up “money” in its own currency is to have a negative amount of debt - i.e., the private sector issues debt to the government to meet tax obligations. This is an fairly unusual situation, but the rainy day fund is not really money, it consists of private sector debt.</p>

CC BY-SA 4.0
2020-06-20T09:30:09.923Z
You rightfully point out some inconsistency in my question -- that a governmental reserve fund, if stored in fiat money, is in some foreign currency over whose value the government does no have direct control but only indirect influence as any other private entity (albeit stronger).
Alex Serenko
CC BY-SA 4.0
2020-06-20T09:30:13.803Z
However, you write that an increase in a fund reduces aggregate demand, leading to mild deflation. Therefore, spending a fund would do the opposite. I ask, for a sovereign, why doesn't it print currency instead if the effect would be essentially the same, and for a sub-sovereign, what is the purpose of a reserve if it cannot be spent without an (undesitrable) inflation. https://economics.stackexchange.com/a/37400/28455 answers my question by arguing that the effect will not be exactly the same.
Alex Serenko
CC BY-SA 4.0
2020-06-20T14:51:09.170Z
The other answer suggests that “rational expectations” suggests that the outcome is different. This answer is not  taking into account that the sovereign owns the central. I have never seen a neoclassical model where an internal debt between the central bank and Treasury has an effect on anything. Sub-sovereigns are different - they are a distinct actor. However, their rainy day funds are typically far too small to have a measurable effect on the economy
Brian Romanchuk
CC BY-SA 4.0
2020-06-20T16:30:27.247Z
please do not focus so much on own-currency funds. Spending a governmental-scale fund will have a notable effect on the economy (inflation, I suppose in the question). This limits the govt's ability to spend the fund, and thus, the purpose of reserve funds for a government must be principally different than just "let's save for a rainy day" which would be perfectly reasonable for a minor actor. This holds regardless of the currency/asset of the fund. Sorry again for failing to convey this.
Alex Serenko
CC BY-SA 4.0
2020-06-20T20:09:12.643Z
Do you have any examples of a sovereign having such a large fund In its own currency? Because of the problems I outlined, large funds of that sort do not exist in any country that I am aware of.
Brian Romanchuk
CC BY-SA 4.0
2020-06-20T22:39:07.707Z
all right, I do understand that the fund is not in the state's own currency. I even added this to my question. Now could you please elaborate on the folllowing part: "Sovereigns also build up foreign currency reserves. These are used to meet potential needs to pay for imports, or pay financial obligations." Won't paying out a large fund, regardless of what currency/assets constitute it, cause inflation in the market where it is spent?
Alex Serenko
CC BY-SA 4.0
2020-06-19T13:03:24.957Z
2020-06-20T23:25:20.663Z
2020-06-20T23:25:20.663Z
Brian Romanchuk
<p>It is a common knowledge and has been explained <a href="https://economics.stackexchange.com/a/37046">here on SE</a> that the source of value is production and consumption rather than money, and that accumulating money is thus pointless. Yet, &quot;rainy day funds&quot; do just that. What is their purpose?</p>
<p>For a layman like me, it seems extracting money from circulation to a reserve decreases inflation, while using that money later would just increase inflation. Then, I must be misunderstanding some basics.</p>
<p>Indeed, a sovereign does not normally save in its own currency, but rather in foreign currencies or other valuable assets, over the value of which it has no direct control, but only an indirect influence as any other actor. However, for a governmental-scale fund, the influence (presumably deflationary for increasing the fund and inflationary for spending it) would be so strong that it may print new money as well. Where is my understanding flawed?</p>

CC BY-SA 4.0
2020-06-19T10:40:40.900Z
I have forgotten that governments do not usually store reserves in their own currencies. In that case, the "how using reserves reserving is different to printing" part should be read as "how the impact on the economy of using reserves is different from that if the emittent country printed that money".
Alex Serenko
CC BY-SA 4.0
2020-06-19T12:40:02.883Z
The only governments that have reserve funds that I am aware of sub-sovereigns (e.g., U,S. states). Very big difference between sub-sovereign and a sovereign. Or are you aware of sovereigns with (non-fireign currency) reserve funds?
Brian Romanchuk
CC BY-SA 4.0
2020-06-20T09:17:10.690Z
@BrianRomanchuk, I admit my question does not state what currency or commodity constitutes the fund. However, while that might have been relevant, I am generally interested in a situation where a fund, whatever valuable assets it consists of, is so huge that spending it would drive inflation through the roof, which makes the government effectively unable to spend its savings. Then, my question is about sovereigns because I ask why they don't print money if the inflating effect of that would be essentially the same as if they spent their reserves.
Alex Serenko
CC BY-SA 4.0
2020-06-20T22:55:06.140Z
@BrianRomanchuk, honestly, my question is inspired by some ongoing discission in my country about whether people should be paid from the National Wealth Fund to support them in the recent lockdown. While the fund is actually stored mainly in stocks, payouts would certainly be performed in the country's own currency. Anyway, I realised I didn't understand how and why a governmental fund can help in such situation, because it certainly works not the way (and can't be spent in the way) minor actors' savings do.
Alex Serenko
<inflation><monetary-policy>
How is using a reserve fund different from printing money?
Alex Serenko
# How is using a reserve fund different from printing money?

(Asked by: username_0 on 2020-06-19)

It is a common knowledge and has been explained [here on SE](https://economics.stackexchange.com/a/37046) that the source of value is production and consumption rather than money, and that accumulating money is thus pointless. Yet, "rainy day funds" do just that. What is their purpose?

For a layman like me, it seems extracting money from circulation to a reserve decreases inflation, while using that money later would just increase inflation. Then, I must be misunderstanding some basics.

Indeed, a sovereign does not normally save in its own currency, but rather in foreign currencies or other valuable assets, over the value of which it has no direct control, but only an indirect influence as any other actor. However, for a governmental-scale fund, the influence (presumably deflationary for increasing the fund and inflationary for spending it) would be so strong that it may print new money as well. Where is my understanding flawed?

**Tags:** inflation, monetary-policy

> **Comments:**
> **username_0**: I have forgotten that governments do not usually store reserves in their own currencies. In that case, the "how using reserves reserving is different to printing" part should be read as "how the impact on the economy of using reserves is different from that if the emittent country printed that money".  
> **username_1**: The only governments that have reserve funds that I am aware of sub-sovereigns (e.g., U,S. states). Very big difference between sub-sovereign and a sovereign. Or are you aware of sovereigns with (non-fireign currency) reserve funds?  
> **username_0**: @username_1, I admit my question does not state what currency or commodity constitutes the fund. However, while that might have been relevant, I am generally interested in a situation where a fund, whatever valuable assets it consists of, is so huge that spending it would drive inflation through the roof, which makes the government effectively unable to spend its savings. Then, my question is about sovereigns because I ask why they don't print money if the inflating effect of that would be essentially the same as if they spent their reserves.  
> **username_0**: @username_1, honestly, my question is inspired by some ongoing discission in my country about whether people should be paid from the National Wealth Fund to support them in the recent lockdown. While the fund is actually stored mainly in stocks, payouts would certainly be performed in the country's own currency. Anyway, I realised I didn't understand how and why a governmental fund can help in such situation, because it certainly works not the way (and can't be spent in the way) minor actors' savings do.  

---

## 1 answers

### Answer by username_1 on 2020-06-19. Score: 2 | Accepted answer

Update: the question was updated to make it clear that what is in mind is a foreign currency fund.

There seem to be two main reasons to build up a foreign currency reserve.

1. A country has valuable natural resources (typically oil), and a reserve is built up to generate claims on the rest of the world for the time after the resource runs down, and to prevent the domestic currency from getting too strong (which damages the competitiveness of the non-resource industries). Similarly a country might keep its currency undervalued to support export-led growth, which requires building up reserves.
2. Build up reserves as a defensive measure, so that it is possible for domestic entities to import goods and service foreign debt. This strategy blends in with export-led growth strategies.

The build up and run down of foreign currency assets is somewhat independent to domestic policy settings, as it a redirection of trade income flows.

For example, if the country spends its rainy day fund, it is presumably to import foreign goods. This means that the extra demand is being met from global productive capacity, and thus it likely has negligible inflationary effect on the domestic economy.

Building up the fund may also not be associated with reducing growth. If it is built up as part of an export-led strategy, growth may be higher (as was the case in Japan and China).

The rest of this answer discusses the issue of rainy day funds in a local currency.

A sub-sovereign does not issue the currency, but has obligations in the currency. It builds up a “rainy day” fund for the same reason an entity in the private sector does - to meet unexpected demands for cash. An increase in the rainy day fund acts as a form of saving, reducing aggregate demand. This will have a mildly deflationary effect. Unwinding the fund is mildly inflationary. This is true of any other entity in the economy that is not the central government, and in most cases, the effect of one sub-sovereign is not measurable.

However, sovereigns cannot really create “rainy day” funds in their own currency. They do keep balances at the central bank, which look like rainy day funds. But since the central bank is owned by the government, this deposit is a internal obligation of the consolidated entity - a debt the consolidated entity owns to itself. As such, the entry is largely cosmetic, and should have no measurable effect on the economy. (For example, such deposits disappear from standard macro models.)

Once again, a sovereign’s “rainy day fund” in its own currency is a debt it owes to itself. Any entity can create infinitely large debts to itself. For example, you can write an IOU to yourself for \$1 billion, and you have a \$1 billion in assets! However, this has not affected your net worth. Your net worth is what matters for economic outcomes, and thus such self-debt has no effect on anything.

About the only way for a central government to save up “money” in its own currency is to have a negative amount of debt - i.e., the private sector issues debt to the government to meet tax obligations. This is an fairly unusual situation, but the rainy day fund is not really money, it consists of private sector debt.

> **Comments:**
> **username_0**: You rightfully point out some inconsistency in my question -- that a governmental reserve fund, if stored in fiat money, is in some foreign currency over whose value the government does no have direct control but only indirect influence as any other private entity (albeit stronger).  
> **username_0**: However, you write that an increase in a fund reduces aggregate demand, leading to mild deflation. Therefore, spending a fund would do the opposite. I ask, for a sovereign, why doesn't it print currency instead if the effect would be essentially the same, and for a sub-sovereign, what is the purpose of a reserve if it cannot be spent without an (undesitrable) inflation. https://economics.stackexchange.com/a/37400/28455 answers my question by arguing that the effect will not be exactly the same.  
> **username_1**: The other answer suggests that “rational expectations” suggests that the outcome is different. This answer is not  taking into account that the sovereign owns the central. I have never seen a neoclassical model where an internal debt between the central bank and Treasury has an effect on anything. Sub-sovereigns are different - they are a distinct actor. However, their rainy day funds are typically far too small to have a measurable effect on the economy  
> **username_0**: please do not focus so much on own-currency funds. Spending a governmental-scale fund will have a notable effect on the economy (inflation, I suppose in the question). This limits the govt's ability to spend the fund, and thus, the purpose of reserve funds for a government must be principally different than just "let's save for a rainy day" which would be perfectly reasonable for a minor actor. This holds regardless of the currency/asset of the fund. Sorry again for failing to convey this.  
> **username_1**: Do you have any examples of a sovereign having such a large fund In its own currency? Because of the problems I outlined, large funds of that sort do not exist in any country that I am aware of.  
> **username_0**: all right, I do understand that the fund is not in the state's own currency. I even added this to my question. Now could you please elaborate on the folllowing part: "Sovereigns also build up foreign currency reserves. These are used to meet potential needs to pay for imports, or pay financial obligations." Won't paying out a large fund, regardless of what currency/assets constitute it, cause inflation in the market where it is spent?  

---

