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It is a common knowledge and has been explained here on SE 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?

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  • $\begingroup$ 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". $\endgroup$ – Alex Serenko Jun 19 at 10:40
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    $\begingroup$ 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? $\endgroup$ – Brian Romanchuk Jun 19 at 12:40
  • $\begingroup$ @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. $\endgroup$ – Alex Serenko Jun 20 at 9:17
  • $\begingroup$ @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. $\endgroup$ – Alex Serenko Jun 20 at 22:55
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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.

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  • $\begingroup$ 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). $\endgroup$ – Alex Serenko Jun 20 at 9:30
  • $\begingroup$ 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. economics.stackexchange.com/a/37400/28455 answers my question by arguing that the effect will not be exactly the same. $\endgroup$ – Alex Serenko Jun 20 at 9:30
  • $\begingroup$ 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 $\endgroup$ – Brian Romanchuk Jun 20 at 14:51
  • $\begingroup$ 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. $\endgroup$ – Alex Serenko Jun 20 at 16:30
  • $\begingroup$ 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. $\endgroup$ – Brian Romanchuk Jun 20 at 20:09
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No, accumulating money is not pointless. Money not being the source of value does not lead to it being of no value.

Money, including the type we use right now -called "fiat money"-, has 3 properties.

  1. It is an accepted tool for carrying out transactions.
  2. It is a way to measure a product's value.
  3. It is a store of value.

The 3rd point is the one you're looking for. As long as the value of money (its purchasing power) does not drop then it is a proper way of storing value; you can keep your money and use it in the future (a "rainy day fund" perhaps)- this wouldn't happen if you were exchanging fish for cows for example.

It is apparent that money is not the best store of value, since it doesn't give its holder any interest just for holding it, unlike deposits in a bank, bonds and stocks.

A state can have multiple sources of property, money being one type of it. For reasons of diversification to risk it is preferred that assets are not of the same type.

On the topic of inflation and efficiency;

Neoclassical theory suggests that storing a reserve fund is not the same with money being destroyed and then printed anew. Everyone knows this money exists and is being stored, and will be used in case of need. So people, having rational expectations, already understand this amount of money as part of monetary policy and the implications of such policy (including inflation); which means that the current price level is already adjusted for this inflation.

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  • $\begingroup$ Very nice explanation, thank you! However, it is still unclear to me how money can be a store of value on a state level. The Wikipedia page en.wikipedia.org/wiki/Store_of_value#Money_as_a_store_of_value is of little help, and it seems not to distinguish macroeconomics and microeconomics. In layman's terms: 1. Printing money causes inflation. 2. Destroying money decreases inflation. 3. Keeping money in a fund is essentially the same as if it was destroyed and then printed anew. 4. Why keep it in a fund then? $\endgroup$ – Alex Serenko Jun 19 at 10:21
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    $\begingroup$ By the way also I would like to add that any money has those 3 properties no matter if money is fiat or commodity based - those three properties are how we define money $\endgroup$ – 1muflon1 Jun 19 at 10:23
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    $\begingroup$ @AlexSerenko Neoclassical theory suggests it is not the same with it being destroyed and then printed anew. Everyone knows this money exists and is being stored, and will be used in case of need. So people, having rational expectations, already understand this amount of money as part of monetary policy and the implications of such policy (including inflation); which means that the current price level is already adjusted for this inflation. $\endgroup$ – the_rainbox Jun 19 at 10:33
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    $\begingroup$ @the_rainbox, your words about how people knowing the fund exists and will be used in need leads to the money effectively being not entirely extracted from circulation hit the nail on the head! This is what I was looking for. Maybe you could edit that into your answer? $\endgroup$ – Alex Serenko Jun 19 at 10:52
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    $\begingroup$ Yes, by store of value, we mean that people understand them and use them as a store of value. This is true for everything though. Every definition of value we give is subjective; even the fruits of labor are only valuable because man values his labor over doing something else, like sleeping. The universe doesn't care about our labor, we live in a self-made construct. I'm in no position to say that there's an intrinsic value within anything; my opinion is that value is man-made; much like money. So it's not so far from being of actual value, since actual value is also what man makes it. $\endgroup$ – the_rainbox Jun 20 at 14:08

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