WHAT IS 'Macroeconomic Stabilization Fund (FEM)'

The Macroeconomic Stabilization Fund (FEM) was established by Venezuela to stabilize cash flow from oil production.

BREAKING DOWN 'Macroeconomic Stabilization Fund (FEM)'

The Macroeconomic Stabilization Fund (FEM) was created in 1998 at the request of the International Monetary Fund, or IMF, as a fund to receive income generated from oil production above a certain price per barrel and pay out the difference if the price falls below that level. Regulation of the fund by the central bank board began in 1999. By December 2001, the fund had US$7.1 billion in assets. In 2003, the government tapped the fund to cover its fiscal budget deficit, withdrawing more than US$6 billion.

Stabilization funds

A stabilization fund is a mechanism set up by a government or central bank to insulate the domestic economy from large influxes of revenue, such as from commodities such as oil. A primary motivation is maintaining steady government revenue in the face of major commodity price fluctuations as well as the avoidance of inflation. This usually is accomplished through the purchase of foreign denominated debt, especially if the goal is to prevent overheating in the domestic economy. The first such fund was in Kuwait in 1953. Stabilization funds since have been set up for Russia, Norway, Chile, Oman, Kuwait, Papua New Guinea the UAE and Iran. They also may be set up for exchange rate stabilization as in the European financial Stability Facility, the UK Exchange Equalization Account and the US Exchange Stabilization Fund.

Dependence on revenue from natural resources tends to cause fiscal volatility and macroeconomic instability. Reducing this dependence is made difficult by the so-called Dutch Disease, which occurs when the production of natural resources attracts large foreign capital inflows. This in turn causes appreciation of the real exchange rates and weakens the competitiveness of domestic tradable sectors. The current account deteriorates, making the economies vulnerable to price swings. In addition, governments of resource-rich economies, especially those lacking strong institutional and legal framework, tend to make more-than-proportional increases in discretionary spending following commodity-driven fund inflows.

Studies have shown that stabilization funds contribute to smoothing government expenditure. Expenditure volatility in countries with stabilization funds can be 10-15 percent percent lower than that in economies without them. Stabilization funds can smooth expenditure volatility. A strong institutional framework is key in managing stabilization funds and their resources. Export product diversification tends to reduce expenditure volatility. Countries with better-managed real expenditure have less volatile public spending. And then, domestic and international financial markets can function as buffers to smooth expenditures. Better institutions have been shown to reduce fiscal volatility.

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