Report to Congress on International 

Economic and Exchange Rate Policies 

U.S. Department of the Treasury 

Office of International Affairs 

December 27, 2011 

 

This Report reviews developments in international economic and exchange rate policies and is submitted 

pursuant to the Omnibus Trade and Competitiveness Act of 1988, 22 U.S.C. § 5305 (the “Act”).1

 

1

The Treasury Department has consulted with the Board of Governors of the Federal Reserve System and IMF 

management and staff in preparing this Report. 
Table of Contents 

KEY FINDINGS .......................................................................................................................................................... 2

INTRODUCTION ....................................................................................................................................................... 5

U.S. MACROECONOMIC TRENDS ........................................................................................................................ 5

THE GLOBAL ECONOMY ...................................................................................................................................... 9

U.S. INTERNATIONAL ACCOUNTS .................................................................................................................... 13

THE DOLLAR IN FOREIGN EXCHANGE MARKETS ..................................................................................... 14

ANALYSES OF INDIVIDUAL ECONOMIES ...................................................................................................... 15

ASIA ........................................................................................................................................................................ 15

China ................................................................................................................................................................. 15

Japan ................................................................................................................................................................. 19

South Korea ....................................................................................................................................................... 21

Taiwan ............................................................................................................................................................... 23

EUROPE .................................................................................................................................................................. 24

Euro Area .......................................................................................................................................................... 24

Switzerland ........................................................................................................................................................ 25

United Kingdom ................................................................................................................................................ 26

WESTERN HEMISPHERE ......................................................................................................................................... 27

Brazil ................................................................................................................................................................. 27

Canada ............................................................................................................................................................... 28

Mexico ............................................................................................................................................................... 29

GLOSSARY OF KEY TERMS IN THE REPORT ................................................................................................ 31

 

1
Key Findings 

The Omnibus Trade and Competitiveness Act of 1988 (the "Act") requires the Secretary of the 

Treasury to provide semiannual reports on the international economic and exchange rate policies of 

the major trading partners of the United States. Under Section 3004 of the Act, the Report must 

consider "whether countries manipulate the rate of exchange between their currency and the United 

States dollar for purposes of preventing effective balance of payments adjustment or gaining unfair 

competitive advantage in international trade." This Report covers developments in the first half of 

2011 and, where pertinent and available, data through mid-December 2011. Treasury has concluded 

that no major trading partner of the United States met the standards identified in Section 3004 of the 

Act during the period covered in the Report. 

The pace of U.S. economic growth slowed markedly during the first half of 2011, to just 0.9 percent 

at an annual rate, due partly to temporary factors, then picked up in the third quarter to a 1.8 percent 

annualized rate of growth. Private sector forecasters are projecting growth of 2.25 percent in 2012. 

Unemployment is still high at 8.6 percent, although 2.9 million private sector jobs have been added 

over the past 21 months. Boosting growth and creating jobs in the near term remains a key 

Administration priority. At the same time, the Administration is firmly committed to putting U.S. 

government finances on a sustainable trajectory. Significant deficit reduction was recently ensured by 

the Budget Control Act, which became law on August 2, 2011, but additional deficit reduction is 

clearly necessary to restore long-term fiscal sustainability. 

Following modest global growth in the first half of 2011, driven principally by emerging market 

economies, rising financial stress in the euro area dampened the global outlook. Economic and 

financial stresses in the euro area have spread to some of its largest economies, with sharp increases 

in sovereign bond yields and indicators of banking stress. This has adversely affected credit, 

confidence, and growth in the euro area. Many private sector forecasters are now projecting negative 

growth over the next several quarters in some euro area economies. 

Global financial markets are strongly interconnected. The deepening of Europe's crisis has already 

impacted global capital flows and the currency markets. Although most emerging market currencies 

appreciated against the dollar in the first half of 2011, in many cases that appreciation was more than 

unwound in the second half of 2011 as risk aversion increased. The European crisis remains a 

significant risk to the global recovery. Growth forecasts for 2012 have been repeatedly reduced. 

Consensus Forecasts in early December projected just 2.7 percent global growth in 2012, down from 

3.2 percent projected in September. 

This report reviews the exchange rate policies of ten economies accounting for 70 percent of U.S. 

foreign trade. Foreign exchange markets have functioned well and in an orderly manner over the past 

year despite broader turmoil in the global economy, and real effective exchange rates for the major 

advanced economies are in line with historic norms. All of the major advanced economies have fully 

flexible exchange rates, although in a notable change from recent practice, Japan twice announced it 

intervened unilaterally in the past year. Among major emerging market economies, a select few have 

more tightly managed exchange rates, with varying degrees of management. This Report highlights 

the need for greater exchange rate flexibility in these economies and most notably in China. 

2
Over the past decade, China has resisted very strong market pressures for RMB appreciation. 

China’s real effective exchange rate has exhibited persistent and substantial undervaluation, although 

the estimated range of misalignment has narrowed over the course of the past 18 months. 

China held more than $3.2 trillion in foreign exchange reserves at the end of September 2011 – with 

$373.1 billion of foreign exchange reserves accumulated in the first three quarters of 2011. In the 

fourth quarter of 2011, reserve accumulation likely slowed significantly, and the RMB has at times 

traded at or near the bottom end of the trading band, as capital inflows to China and other emerging 

markets diminished, and as increased uncertainty about the global economy reduced market 

expectations of continued RMB appreciation against the dollar. 

These recent events reflect the particular conditions and risks facing the global economy at this 

moment, as well as investors' expectations of likely Chinese policy responses, and are not an 

indication that the process of required adjustment has been completed in China. Slowing growth and 

diminished import demand in Europe has already begun to slow the exports of China and other 

emerging markets. Increased prices for China's commodity imports have also significantly reduced 

China's trade surplus. 

Despite these short-term forces, the underlying factors that distort China's economy and constrain 

global growth remain. China continues to increase its global export market share, it remains heavily 

dependent on exports, and it has made little progress in making the required shift to domestic 

consumption. China's large foreign reserve accumulation has prolonged the misalignment in China’s 

real effective exchange rate and hampered progress toward global rebalancing, including among 

economies that compete with China for exports. 

While China’s real exchange rate has appreciated, the process of appreciation remains incomplete. 

China’s long-standing pattern of reserve accumulation, the persistence of its current account surplus 

and the incomplete appreciation of the renminbi, especially given rapid productivity growth in the 

traded goods sector, indicate that the real exchange rate of the renminbi is persistently misaligned 

and remains substantially undervalued. 

It is in China's interest to allow the exchange rate to continue to appreciate, both against the dollar 

and against the currencies of its other major trading partners. A lack of continued appreciation by 

China would prevent the exchange rate from serving as a tool to encourage consumption so as to 

maintain strong, sustainable growth, further complicate the adjustment needed for broader financial 

sector reform, and undermine China's stated goal of strengthening domestic demand. 

The Chinese leadership has identified shifting away from growth driven by exports toward a greater 

reliance on domestic consumption as a critical goal for sustaining growth in the medium term. At the 

G-20 Leaders Summit in Cannes in November, G-20 members, including China, committed to, 

"move more rapidly toward more market-determined exchange rate systems and enhance exchange 

rate flexibility to reflect underlying economic fundamentals, avoid persistent exchange rate 

misalignments and refrain from competitive devaluation of currencies." China also stated that its 

rebalancing actions "will be reinforced by ongoing measures to promote greater exchange rate 

flexibility to better reflect underlying economic fundamentals, and gradually reduce the pace of 

accumulation of foreign reserves." 

Since the authorities decided in June 2010 to allow the exchange rate to appreciate, the renminbi has 

appreciated by a total of 7.5 percent against the dollar, as of December 16. Taking into account the 

3
higher rate of domestic inflation in China than in the United States, the renminbi has appreciated 

against the dollar on a real, inflation-adjusted basis by nearly 12 percent since June 2010 and nearly 

40 percent since China first initiated currency reform in 2005. 

Based on the ongoing appreciation of the renminbi against the dollar since June 2010, the decline in 

China's current account surplus, and China's commitments at the G-20 and the U.S.-China Strategic 

and Economic Dialogue (S&ED) asserting that it will continue to promote faster RMB exchange rate 

flexibility, Treasury has concluded that the standards identified in Section 3004 of the Act during the 

period covered in this Report have not been met with respect to China. 

Nonetheless, in light of the persistent misalignment of the RMB at a substantially undervalued level, 

Treasury assesses that movement of the RMB to date is insufficient and more progress is needed. 

Treasury will continue to closely monitor the pace of RMB appreciation and press for policy changes 

that yield greater exchange rate flexibility, level the playing field, and support a pronounced and 

sustained shift to domestic-demand led growth. 

4
Introduction 

This Report focuses on international economic and foreign exchange developments in the first 

nine months of 2011. Where pertinent and when available, data and developments through midDecember are included. 

Exports and imports of goods to and from the areas whose economies and currencies are 

discussed in this Report accounted for 70 percent of U.S. merchandise trade in the first ten 

months of 2011. 

U.S. Macroeconomic Trends 

Real GDP grew by 3.1 percent during 2010, but the ongoing recovery slowed markedly during 

the first half of 2011 as a number of temporary factors weighed on economic activity (most 

notably the Japanese earthquake and tsunami). The pace of expansion picked up in the third 

quarter of 2011, led by stronger growth of consumer spending and business investment. 

Nonetheless, the unemployment rate remained elevated, and the housing sector continued to be a 

point of weakness. Home sales and residential construction have been held back by a number of 

factors, including excess supply, relatively tight lending standards, uncertainty about future 

house prices, and the high level of unemployment. Still, food and energy price inflation has 

moderated in recent months, which should provide some support for consumer purchasing power 

and relieve pressure on business input costs. 

The economy is expected to expand at a moderate pace through the end of 2012. A consensus of 

private forecasters expects real GDP to grow at a 2.7 percent annual rate in the fourth quarter of 

2011 and at a 2.2 percent annual rate over the four quarters of 2012. 

The deeper crisis now facing Europe, however, is a significant risk to the U.S. outlook as our 

recovery remains fragile and vulnerable to events abroad. A tightening of financial markets in 

Europe can adversely impact the willingness of U.S. banks to lend and invest. Our trade 

connections with Europe are broad and deep. It remains of critical importance to the U.S. and 

the global economy that Europe mobilize the resources needed to respond effectively to 

economic and financial stress. 

U.S. Economic Growth Moderated in the First Half of 2011 

The Bureau of Economic Analysis’s annual revisions to the national income and product 

accounts, released in late July, showed that the Great Recession was even more severe than 

previously estimated. From the GDP peak in late 2007 through the trough in June 2009, real 

GDP fell by a cumulative 5.1 percent (revised down from a 4.1 percent decline). Growth was 

slower in 2008 as well as 2009, reflecting weaker consumer spending and business investment. 

The economy began to grow again in the second half of 2009, and over the four quarters of 2010, 

real GDP expanded by 3.1 percent. The pace of growth slowed sharply in the first half of 2011, 

to just 0.9 percent at an annual rate, as a number of temporary factors including surging energy 

prices, supply-chain disruptions stemming from the disaster in Japan, and poor weather early in 

5
the year curtailed economic activity. The absence of these factors in the second half of 2011 set 

the stage for a stronger pace of growth and, in the third quarter, real GDP growth accelerated to a 

1.8 percent annual rate. 

Consumer spending strengthened in the third quarter, rising by 1.8 percent at an annual rate, 

following a tepid 0.7 percent gain in the second quarter. Business fixed investment also grew at 

a faster rate, accelerating to a 13.0 percent pace from 9.2 percent in the second quarter. The 

pickup reflected stronger growth of equipment and software spending. Growth of outlays for 

nonresidential structures moderated in the third quarter, but was still relatively strong. Even so, 

the level of investment in business structures remained very low, at just 10 percent above the 33-

year low recorded in early 2010. 

Residential investment edged higher in the third quarter, but made very little contribution to real 

GDP growth. Housing activity has been essentially neutral for growth since mid-2009, shaving 

0.03 percentage point per quarter, on average, off of real GDP growth from the third quarter of 

2009 through the third quarter of 2011. In the previous four years, residential investment 

reduced growth by an average of 0.8 percentage point per quarter. 

Private domestic final demand (the sum of consumer spending and private fixed investment) 

accelerated sharply in the third quarter to a 3.4 percent annual rate, from just under 2 percent in 

the first half of the year. Trade was also a bright spot in the third quarter, as exports once again 

grew faster than imports. The resulting decline in the net export deficit contributed 

0.4 percentage point to real GDP growth. 

The pickup in underlying private demand and improvement in the trade balance was partly offset 

by a marked slowdown in private inventory accumulation, which subtracted 1.4 percentage 

points from third-quarter real GDP growth after trimming 0.3 percentage point from growth in 

the second quarter. Government purchases edged down at a 0.1 percent annual rate in the third 

quarter as a 2.1 percent increase in Federal government outlays was slightly more than offset by 

continued cutbacks at the state and local level. 

The Housing Sector Remained Weak 

Housing activity remained very weak during the first three quarters of 2011. Housing starts 

averaged 592,000 at an annual rate through October — a modest improvement compared to the 

585,000 starts averaged over all of 2010. Nevertheless, single-family home building remains 

close to a historically low level. Despite record low mortgage rates and a near-record level of 

housing affordability, home sales remained depressed. Sales of new single-family homes through 

October averaged 302,000 at an annual rate, putting them on track to hit a new annual all-time 

low in 2011.2

 Sales of existing single-family homes averaged 4.36 million at an annual rate 

through October 2011, up just 1 percent from 4.31 million in 2010, the worst year on record for 

single-family home sales (dating back to 1968). 

 

2

 The data series started in 1963. 

6
Housing demand remains constrained by relatively tight lending standards, uncertainty about 

future home prices, and the high level of unemployment. While the inventory of homes 

available for sale has fallen a great deal over the past several years, it is still very high relative to 

sales. At the end of October there was a 6.3-month supply of new homes on the market, roughly 

in line with the long-term average. However, the supply of existing homes available for sale (94 

percent of all home sales) was still elevated at an 8.0-month supply level; nearly double the 

average level that prevailed prior to the housing bubble. In addition, there is a large shadow 

inventory of homes (either in foreclosure or with mortgages more than 90 days past due) with the 

potential to add significantly to the number of homes available for sale in the future. The 

overhang of homes on the market has held back new construction and put downward pressure on 

house prices. House price measures have shown signs of stabilization in recent months but 

continued to decline on a year-over-year basis. The S&P/Case-Shiller 20-city house price index 

fell 3.6 percent below its year-earlier level in September. The FHFA house price index fell 2.2 

percent over the year ending in September. 

Labor Market Conditions Continued to Improve 

The strength of the labor market recovery waned during the summer but has more recently 

shown signs of improvement. On average, nonfarm payrolls increased by 132,000 per month in 

the first eleven months of 2011, up from a monthly average of 78,000 in 2010. Nearly 

2.5 million jobs have been created since February 2010, including 2.9 million in the private 

sector. The unemployment rate fell a full percentage point between November 2010 and March 

2011 to 8.8 percent, but edged higher in subsequent months and remained just above 9 percent 

until recently. In November, the unemployment rate fell 0.4 percentage point to 8.6 percent – the 

lowest since March 2009. Despite these gains, private employment is still 5.9 million lower than 

at the start of the recession in December 2007 and the unemployment rate is 3.6 percentage 

points higher. In addition, long-term unemployment (the share of the unemployed out of work 

for 27 weeks or more) remains very high at 43 percent, close to the record level of 45.6 percent 

posted in May 2010. 

Energy Prices Have Eased from Peaks Earlier in the Year 

Energy prices rose sharply earlier in the year, but moderated during the spring and summer. The 

front-month futures contract for West Texas Intermediate crude oil surged from around $85 per 

barrel in mid-February to nearly $114 per barrel at the end of April. U.S. consumers and 

businesses faced sharply higher fuel costs as a result: between mid-February and mid-May, the 

U.S. average retail price for regular gasoline climbed 82 cents (or 26 percent) to $3.96 per 

gallon. The price of oil trended lower from late April through early October, dipping to a low of 

$76 per barrel, but has since moved higher and in early December touched the $100 mark. The 

retail price of gasoline has declined by more than 60 cents since mid-May to around $3.30 per 

gallon. 

Core Inflation Accelerated but Remains Low 

Rising energy prices and a pickup in food price inflation pushed headline inflation measures 

higher in the first eleven months of 2011. Core inflation remained relatively subdued, however, 

7
reflecting the large degree of slack in labor markets and low level of capacity utilization. The 

consumer price index rose 3.4 percent over the year that ended in November 2011, up from a 1.1 

percent increase during the year that ended in November 2010. Core consumer prices 

(excluding food and energy) rose 2.2 percent over the year that ended in November 2011, 

compared to 0.8 percent over the same period a year earlier. Growth of compensation costs 

remained contained in the third quarter. The Employment Cost Index (ECI) for private-industry 

workers rose 2.2 percent over the year that ended in September 2011. Recent year-over-year 

gains in this measure are among the smallest in the 30-year history of the data series, as 

comparatively low growth in wages and salaries has offset more rapid increases in benefit costs. 

Fiscal Consolidation is a Priority 

The U.S. economy has made important progress over the past two years, but the recovery is far 

from complete and still not proceeding fast enough to meaningfully bring down the 

unemployment rate. At the same time, the current fiscal trajectory is unsustainable. Left 

unaddressed, our growing debt burden threatens to undermine the foundations of our future 

economic strength. The Administration is firmly committed to putting U.S. government finances 

on a sustainable trajectory. In the near term, however, the economy needs additional support. 

The scheduled expiration of the payroll tax cut and extension of unemployment benefits put in 

place last December, along with the continued fade-out of spending under the American 

Recovery and Reinvestment Act of 2009, is expected to be a substantial drag on the economy in 

2012. Boosting growth and creating jobs in the near term remains an important priority for the 

Administration. 

In early September, the President proposed the American Jobs Act, which would provide 

$447 billion in targeted support for the economy next year. The measures included in this 

package were designed to increase household disposable income and private consumption, spur 

infrastructure investment, prevent hundreds of thousands of teachers from being laid off, and 

reform our unemployment insurance system to make it easier for the unemployed to get back to 

work. 

The President simultaneously called for deficit reduction that is large enough to stabilize the debt 

as a share of GDP. The Budget Control Act enacted in early August was an important first step 

in this direction. It put in place historic cuts in defense and domestic discretionary spending that 

will generate nearly $1 trillion in savings over the next ten years. On September 19, the 

President proposed a comprehensive and balanced deficit reduction plan to offset the cost of the 

American Jobs Act and reduce the 10-year deficit by more than $3 trillion, on top of the roughly 

$1 trillion in spending cuts included in the Budget Control Act. The President’s Plan for 

Economic Growth and Deficit Reduction would generate more revenue and reduce the rate of 

growth in health care spending, while protecting the government’s investments in areas critical to 

economic growth and putting the economy in a stronger position to withstand future shocks. 

Under the President’s plan, the deficit would fall to 2.3 percent of GDP in 2021; in the absence 

of any further deficit reduction, the deficit would be 4.7 percent of GDP in 2021. The plan 

would eliminate the primary deficit by 2017 and debt as a share of the economy would be on a 

declining path. In the absence of the deficit reduction called for in this plan, the debt-to-GDP 

ratio would rise to 86 percent in 2021.

8
The Global Economy 

Global growth was modest in the first half of 2011, driven principally by the emerging market 

economies. By the third quarter, however, the global economic outlook had started to deteriorate 

as strains in Europe’s sovereign debt and financial markets increased and started to spill over 

into global markets. The euro area now faces the prospect of slipping into recession, with most 

forecasts projecting a fall in euro area output in the fourth quarter. 

Moderate Growth in the First Half of 2011 

Most of the advanced economies (AEs) 

continued to recover in early 2011, although 

generally at a slower-than-optimal pace. By 

mid-year, among G-7 economies only Canada 

had moved from the recovery to expansionary 

stage (output above pre-crisis levels), as s

in the graph to the right. The Japanese 

economy, which had faltered in late 2010, was 

severely affected by the March 2011 

earthquake and tsunami. The disaster also 

disrupted global supply chains, resulting in a 

drag on growth in many economies in mid2011. 

hown 

The slow pace of growth in most AEs has 

hindered the recovery of labor markets. 

Among the G-7, only Canada and Germany 

have seen employment expand beyond precrisis levels. 

In contrast, the emerging market economies 

(EMEs) continued to grow at a brisk pace in 

early 2011. All of the EMEs covered in this 

report had moved from recovery to expansion 

(as shown in the second graph) by the 

beginning of the year. 

Growth in these economies was supported by a recovery in global trade, accommodative 

macroeconomic policies, and strong capital inflows. Rapid growth combined with stimulative 

macroeconomic policies helped fuel inflationary pressures. These factors together with rising 

food prices led inflation to move upward in many EMEs. Starting in late 2010, central banks in 

several EMEs had begun to raise interest rates; they continued to do so into 2011. The 

combination of rising inflation and increased capital inflows made some EMEs reluctant to rely 

primarily on traditional monetary policy and exchange rate responses. Instead, they opted to rely 

more on the use of capital controls to dampen inflows and prudential measures to limit domestic 

credit growth. 

9
Global Economic Growth Deteriorates in Second Half of 2011 

By late summer, strong headwinds were 

buffeting the global economy. Economic and 

financial stresses in the euro area spread to 

some of its largest economies. Sovereign bond 

yields rose sharply in many countries. Many 

European financial institutions faced 

difficulties raising long-term financing in the 

market. 

The associated rise in risk aversion resulted in a

slowdown in capital flows to emerging ma

and downward pressures on EMEs and other 

non-safe-haven currencies. This can be seen in

the movements in effective exchange rates, as

shown in the graphs to the right. All the 

currencies that had appreciated on a nom

effective basis in the first half of the year 

depreciated during the second half. The Swiss

franc, which is typically a safe-haven currenc

and was under strong upward pressure, 

depreciated as a result of the actions by the 

Swiss National Bank to limit the currenc

upward movement against the euro, as discussed later in this Report. 

rkets 

inal 

y 

y’s 

apid 

By the final months of the year, the global 

growth outlook had deteriorated significantly. 

This reflected the significant strains in Europe’s 

financial markets, the increase in sovereign 

yields in some countries, deleveraging, and r

slowing of growth which weighed further on 

fiscal finances in the affected economies. By 

late in the year, many private and public sector 

forecasts were projecting recessionary 

conditions in the euro area during late 2011 and 

into 2012. Projections for growth in most other 

economies were also lowered. Moreover, in nearly all countries, growth in 2012 is projected to 

be lower than in 2011, as shown in the November 2011 OECD projections. Consensus Forecasts 

in early December projected just 2.7 percent global growth in 2012, down from 3.2 percent 

projected in September. 

Uncertainty surrounding 2012 growth prospects also has risen. Without prompt policy actions, 

the combination of weak credit growth, slumping private sector confidence, and public sector 

expenditure reductions saps growth and has the potential to create a downward, self-reinforcing 

10
spiral resulting in a return to a broader recession affecting more economies. On the upside, 

decisive, comprehensive policy actions to ward off contagion and restore confidence would limit 

the downside risks in Europe and help to secure the global recovery. 

Limited Progress Toward Global Rebalancing 

At the Pittsburgh Summit in 2009, 

Leaders of the G-20 launched a 

Framework for Strong, Sustainable, and 

Balanced Growth. The goal of the 

Framework was to help ensure a better 

balanced global economy that was less 

prone to crisis. Two years later, there 

has been some rebalancing but most of 

this appears to be cyclical. 

As shown in the chart, much of the 

decline in external imbalances has 

resulted from the narrowing of the U.S. current account deficit since 2006. China’s current 

account surplus also has fallen in the past couple of years, but imbalances are expected to rise 

over the medium-term in the absence of structural changes. 

Other indicators also point to limited rebalancing. Recently, the IMF has been publishing 

estimates of real effective exchange rate misalignment for some currencies as part of the 

country’s annual Article IV consultation. These estimates are generally based on the 

methodology developed by the IMF’s 

Consultative Group on Exchange R

(CGER), which uses three models

analyze the degree to which the real 

effective exchange rate deviates 

its medium-term fundamentals. 

three models are: the Macroeconomic 

Balance Model, the Equilibrium Real

Effective Exchange Rate Model

the External Stability Model. 

ates 

 to 

from 

 The 

, and 

he table to the right presents the 

he 

T

estimates, where available, for the 

currencies covered in this Report. T

real effective exchange rates of the 

Brazilian real and U.S. dollar were 

estimated as overvalued. No overall

estimate was provided for the Canadian dollar, but based on the three models it was close to 

medium-term fundamentals. The real effective value of the euro, the yen, the Mexican peso, the 

Swiss franc, and the pound sterling were judged to be in line with medium-term fundamentals. 

The Korean won and the Chinese renminbi were undervalued. 

11
The CGER estimates point to a need for several major emerging market currencies to appreciate 

against the currencies of the advanced economies. The persistent undervaluation of some 

emerging market currencies hinders global rebalancing. 

Another factor pointing to the undervaluation 

of key emerging market currencies and the 

lack of rebalancing has been the continued 

rapid accumulation of foreign currency 

reserves. The table to the right shows the 

dollar value of foreign currency reserves held 

by the economies covered in this report and 

the monthly addition to reserves in the pre-a

post-crisis periods. In all economies, the 

monthly addition to reserves has risen. The 

increase is influenced by valuation gains and 

losses, as well as partly the result of passive 

accumulation, from the interest return on 

reserve holdings. For example, the United 

States added more reserves each month 

between February 2009 and July 2011 than in 

the pre-crisis period, yet has not intervened to purchase foreign currency. In most cases, 

however, the accumulation overwhelmingly reflects intervention in foreign exchange markets 

and in some cases an active intervention policy. 

Foreign Currency Reserve Accumulation

Monthly increase,            

$millions

Reserves  

$millions

Jan 2005 to

Dec 2007

Feb 2009 to

Jul 2011

China 3,245,283 25,846 45,973

Japan 1,071,531 3,622 3,151

Taiwan 400,766 788 3,675

Brazil 336,045 3,200 5,230

Korea 303,942 1,799 3,556

Switzerland 233,691 ‐275 6,564

Euro Area 213,687 542 940

Mexico 126,659 646 1,303

United States* 54,635 116 311

Canada 49,859 255 310

United Kingdom 7,353 ‐170 78

Global 10,195,736 81,666 107,991

nd 

The recent downward pressure on EME currencies, as a result of rising risk aversion and the 

deteriorating growth outlook, has tempered the pace of reserve accumulation. The reversal in 

EME exchange rates (as shown in the charts above) has been the most pronounced since the 

financial crisis. Not only have emerging market central banks not needed to buy foreign 

currency in order to prevent their currencies from rising, but many of the central banks have 

acted to slow the pace of depreciation by selling foreign currency. Preliminary data suggests that 

on a net aggregate basis, EME sales of foreign currency reserves were at their highest level in 

September and October 2011 since the height of the global financial crisis. Once this period of 

global financial stress has passed, reserve accumulation likely will return to its previous pace. 

Conversely, this recent period of global risk aversion has put significant upward pressure on 

many advanced economy currencies. In the face of a deepening crisis in the euro area and large 

safe haven flows that had pushed the Swiss franc to a record high against the euro, Switzerland 

instituted a floor on its bilateral exchange rate with the euro. In addition, Japanese authorities 

announced they twice intervened unilaterally to stem pressure for yen appreciation. 

12
U.S. International Accounts

The U.S. current account deficit narrowed to 2.9 

percent in the third quarter of 2011 after 

averaging 3.2 percent of GDP in the first half of 

2011. The lower deficit was the result of 

continued improvements in the surplus in the 

services trade and on income, combined with a 

reduction in the merchandise trade deficit. 

The dollar value of U.S. exports of goods and 

services in the third quarter of 2011 increased by 15.3 percent over the third quarter of 2010, 

while imports increased by 12.7 percent. In real, price-adjusted terms, exports increased 5.8 

percent and imports increased by 1.9 percent. 

U.S. Balance of Payments and Trade

($ billions, seasonally adjusted unless indicated) 2009 2010 Q4-10 Q1-11 Q2-11 Q3-11

Current Account

 Balance on goods -505.9 -645.9 -159.2 -182.2 -190.6 -181.8

 Balance on services 124.6 145.8 40.5 42.3 44.4 46.2

 Balance on income (including employee compensation) 128.0 165.2 39.9 52.7 56.9 58.3

 Net unilateral current transfers -123.3 -136.1 -33.4 -32.3 -35.4 -33.0

Balance on current account -376.6 -470.9 -112.2 -119.6 -124.7 -110.3

Balance on current account as % of GDP -2.7 -3.2 -3.0 -3.2 -3.3 -2.9

Capital and Financial Account (financial inflow = +)

 Net official assets 428.0 347.9 58.0 45.1 88.9 20.3

 Net bank flows -559.9 -337.9 -64.4 266.6 82.0 77.6

 Net direct investment flows -145.0 -115.1 -22.4 -60.7 -86.4 4.5

 Net sales of securities 210.5 165.1 19.8 -9.4 45.9 -11.8

 Net liabilities to unaffiliated foreigners by nonbank concerns 157.3 84.9 11.0 -53.0 31.3 -0.1

 Other 155.0 109.3 27.4 -32.7 -127.1 93.5

Balance on capital and financial account 245.8 254.1 29.3 156.0 34.6 183.9

Memo Items

Statistical discrepancy 130.8 216.8 82.8 -36.4 90.2 -73.6

Change in foreign official assets in the United States 480.2 349.8 57.8 48.8 95.1 24.4

Trade in Goods

Exports of goods

 Agricultural products 93.9 107.7 30.6 32.0 32.1 30.7

 Industrial supplies and materials (including petroleum) 307.7 406.2 109.7 124.2 129.1 134.0

 Capital goods except autos 390.5 446.6 116.6 117.6 122.2 125.6

 Automotive products 81.7 112.0 29.0 32.0 32.2 34.5

 Consumer goods except autos and food 150.0 165.9 43.6 42.4 44.1 44.5

 Other goods 45.7 50.3 13.2 13.2 13.4 13.4

Total exports of goods 1,069.5 1,288.7 342.7 361.5 373.0 382.7

Imports of goods

 Agricultural products 82.8 92.5 23.9 25.9 27.4 27.2

 Industrial supplies and materials (including petroleum) 478.8 623.8 159.8 187.9 202.5 197.7

 Capital goods except autos 372.7 450.0 119.9 123.4 128.6 129.2

 Automotive products 159.2 225.6 58.6 64.0 58.2 66.8

 Consumer goods except autos and food 432.5 486.6 125.2 128.7 131.4 128.8

 Other goods 49.5 56.1 14.6 13.8 15.6 14.8

Total imports of goods 1,575.4 1,934.6 501.9 543.8 563.6 564.5

Balance of trade in goods -505.9 -645.9 -159.2 -182.2 -190.6 -181.8

Source: Bureau of Economic Analysis (BEA).

Note: Current account + capital and financial account + statistical discrepancy = 0.

13
U.S. exports of goods and services have expanded strongly since the crisis, but imports have 

recovered more slowly. Exports surpassed their pre-crisis level in the fourth quarter of 2010 and, 

as of the third quarter of 2011, were11.0 percent above pre-crisis levels. Imports, however, 

didn’t surpass their pre-crisis peak until the second quarter in 2011 and by the third quarter were 

only 0.4 percent above pre-crisis levels.

The Dollar in Foreign Exchange Markets 

 2011, the dollar’s exchange rate has been 

, 

ed 

, 

 the first half of 2011, the dollar declined 

ging 

he dollar 

ombat rising inflation (e.g., the ECB had already 

ure 

In

affected by various factors including 

changes in interest rate policy expectations

and shifts in global risk appetite. On a 

nominal effective basis, it has depreciat

by 1.1 percent against the major currencies

but is 3.4 percent stronger against the 

emerging market currencies. 

In

by 5.7 percent against the other major 

currencies and 3.2 percent against emer

market currencies. On a real effective basis, 

the dollar fell by 4.9 percent against other 

major currencies and 4.0 percent against 

emerging market currencies. By early August, 

the dollar began an upward trend that has 

continued through mid-December. T

appreciated by 6.8 percent against other major 

currencies between the end of June and midDecember 2011, and by 6.7 percent against 

emerging market currencies. On a real 

effective basis, the appreciation was 4.1 

percent and 4.4 percent, respectively through 

November. 

The shift in dollar sentiment can be seen more 

clearly by looking at its behavior against the 

other currencies covered in this Report during 

the two halves of the year. In the first half of 

2011, the dollar depreciated against all the 

other currencies as a result of weaker growth 

prospects in the U.S. and as expectations for a 

slower pace of monetary policy normalization 

grew. At the same time, investors increased 

their expectations that the European Central 

Bank (ECB) would increase policy rates to c

increased its benchmark interest rate by 25 basis points in April and expectations were that fut

14
increases were on the way), contributing to euro appreciation against the dollar despite ongoing 

concerns regarding the peripheral European sovereign debt crisis. 

In the second half of the year, the dollar appreciated against all of the currencies discussed in this 

ebt 

y year’s end, market participants were primarily focusing on the ongoing debt crisis in Europe 

Analyses of Individual Economies 

Asia 

Report, with the exception of the Japanese yen and the Chinese renminbi. The reversal in the 

dollar’s behavior from earlier in the year resulted from an increase in safe-haven demand in 

response to rising concerns of a global economic slowdown and ongoing stress in European d

markets. 

B

and its potential to affect global economic growth as one of the key drivers of exchange rates. 

China

he Chinese economy continued to expand rapidly in the first three quarters of 2011, growing by 

at 

12, 

t 

 2010 and through much of this year, the increased policy priority China placed on controlling 

10, 

ate 

ore recently, with inflation declining to 4.2 percent year-over-year in November, housing price 

int cut 

he Chinese leadership has identified shifting away from growth driven by exports toward a 

m 

T

9.4 percent year-to-date in real terms. Growth has slowed modestly over the course of the year. 

In the third quarter of 2011, China’s economy expanded by 9.1 percent year-over-year in real 

terms, down from 9.7 percent growth in the first quarter. Most economic forecasters expect th

growth will slow further, particularly if demand for Chinese exports weakens in advanced 

economies. In September, the IMF forecast Chinese real GDP growth of 9.0 percent for 20

down from 9.5 percent in its June forecast, while the OECD now forecasts growth of 8.5 percen

in 2012. 

In

goods and property price inflation led China to tighten monetary and credit policy. The People’s 

Bank of China (PBOC) increased the amount of reserves that large commercial banks were 

required to hold at the central bank, from 15.5 percent of total deposits at the beginning of 20

to 21.5 percent as of November 2011, and provided guidance to banks to constrain the growth of 

lending. These measures were successful in reducing the rate of bank credit growth to 15.6 

percent year-over-year by November 2011, from 19.9 percent in 2010. The inflation rate, 

however, remained high through much of 2011, reaching 6.5 percent in July – the highest r

since June 2008. 

M

increases in China tapering off, and external demand slowing, China has shifted toward 

loosening monetary policy. At the end of November, the PBOC announced a 50 basis po

in the required reserve ratio for all banks, reducing the share of total deposits that large 

commercial banks are required to hold as reserves at the central bank to 21 percent. 

T

greater reliance on domestic consumption as a critical goal for sustaining growth in the mediu

to long term. Actions by China, and other large surplus countries, to shift toward greater reliance

15
on domestic demand for growth are also fundamental to the success of the G-20 goal of assuring 

strong, sustainable, and more balanced global growth in the future. 

China’s 12th Five-Year Plan, adopted on March 14, 2011, and the Joint Fact Sheet of the U.S.-

n 

 

hina also pledged in its Five-Year Plan and at the S&ED to raise the share of the services sector 

and 

s 

to 

xchange rate adjustment is an inherent part of the rebalancing toward domestic demand growth 

 by 

.” Go 

t 

na 

he close relationship between China’s exchange rate policy and broader economic agenda also 

ree 

hina’s current account surplus has fallen from 9.1 percent of GDP in 2008 to 5.2 percent in 

e 

s 

China Strategic and Economic Dialogue (S&ED) meeting in May 2011 also incorporated a 

number of specific and complementary targets to achieve the goals of increasing consumptio

and household incomes. At the S&ED, China committed to take steps to increase its domestic 

consumption, including raising household incomes at a pace faster than GDP growth, steadily 

increasing the minimum wage, and ensuring that wages keep up with increases in productivity.

C

in its economy by four percentage points over the next five years (an important element in 

expanding domestic consumption), and committed to further open its service sector to U.S. 

other foreign participation. Finally, China committed to promote more market-based interest 

rates, which should raise household income and consumption. China’s Five-Year Plan also aim

to substantially expand the social safety net, continue price reform in the resource sector, and 

increase dividend payments by state-owned enterprises. These objectives all could contribute 

the desired shift toward consumption-led growth, and could reduce China’s dependence on 

exports and resource-intensive investment for growth. 

E

that China hopes to achieve, something the Chinese acknowledge. At the November G-20 

Leaders Summit, Chinese authorities stated, “These [rebalancing] actions will be reinforced

ongoing measures to promote greater exchange rate flexibility to better reflect underlying 

economic fundamentals, and gradually reduce the pace of accumulation of foreign reserves

20 members, including China, also stated, “We affirm our commitment to move more rapidly 

toward more market-determined exchange rate systems and enhance exchange rate flexibility t

reflect underlying economic fundamentals, avoid persistent exchange rate misalignments and 

refrain from competitive devaluation of currencies,” and that G-20 members, “welcome ... 

China’s determination to increase exchange rate flexibility consistent with underlying marke

fundamentals.” With the global economy continuing to face headwinds, it is important for Chi

to follow through on these commitments effectively and promptly. 

T

was highlighted by the IMF in their July 2011 “Article IV” consultation on China’s economy. 

IMF staff indicated in the report that a stronger exchange rate was a key ingredient to accelerate

the transformation of China’s economic growth model. In a positive step, China agreed to 

publish the IMF’s estimate of RMB undervaluation in the report. According to the IMF’s th

models, the RMB was estimated to be undervalued by 3, 14, or 23 percent depending on the 

model used. 

C

2010. Preliminary data for the third quarter of 2011 indicated that in the first three quarters th

current account surplus has narrowed to $145.6 billion, equal to 3.0 percent of GDP, compared 

to $203.3 billion and 5.1 percent of GDP in the first three quarters of 2010. Balance of payment

data also indicate that, in the first three quarters of 2011, China experienced a merchandise trade 

16
surplus of $172.9 billion — slightly higher than last year in dollar terms, but falling from 4.3 

percent of GDP in the first three quarter of 2010 to 3.5 percent of GDP this year. 

Box: Costs of Rigid Exchange Rate Management 

China’s relatively inflexible exchange rate regime complicates efforts both to support growth 

and to rebalance and control inflation. Foreign exchange intervention to limit RMB 

appreciation increases the domestic money supply that the PBOC must absorb through 

sterilization to contain inflationary pressures. In addition to issuing bonds through open market 

operations, the PBOC has shifted some of the cost of this sterilization to the banking sector by 

requiring banks to hold a large share of their deposits as reserves paying negative real interest 

rates. The desire to compensate banks for the sterilization costs they bear as a result of China’s 

currency policies has made it more difficult to liberalize deposit rates. 

Low bank deposit rates mean that Chinese households earn very little on what is the largest 

component of their savings, and a declining amount in real terms, as interest earnings fail to 

keep up with inflation. This not only constrains the growth of household income, but forces 

households to save more to meet their financial goals. The IMF recently concluded that a rise 

in deposit rates would lead to an increase in Chinese household consumption, as Chinese 

households not only would see an increase in their income, but would be able to save less while 

still meeting their savings targets. The heavy reliance on administrative controls, combined 

with negative returns on household deposits, also encourages savings and credit to flow outside 

formal loan channels, complicating the PBOC’s and banking regulator’s tasks of managing 

financing conditions and strengthening financial supervision. Moreover the combination of low 

real lending rates and a quota on loans leads to an imbalance between the demand and supply of 

credit, with small and private companies largely bearing the brunt of credit rationing. As China 

pursues the rebalancing agenda in the 12th Five Year Plan, prompt progress on its stated 

objective of advancing interest rate liberalization could be particularly useful. 

Weakness in demand from advanced economies and changing terms of trade have been 

prices 

mber, 

e 

espite these short-term forces reducing China’s current account surplus, the underlying factors 

that distort China’s economy and constrain global growth remain. China continues to increase 

 

significant contributors to the recent decline of China’s current account surplus. Higher 

for commodity imports, for example, are an important reason why China’s recent import price 

increases have outpaced export price rises, holding down the nominal trade surplus.3

 Weakness

in demand in China’s export markets has become more pronounced in recent months. 

Merchandise export growth slowed over the course of 2011 to 21 percent through Nove

compared to 31.3 percent in 2010, as export growth to China’s major markets of the United 

States and the European Union fell to 14.8 percent and 15.1 percent, respectively. At the sam

time, China’s imports rose by 38.7 percent in 2010 and by 26.3 percent in 2011 through 

November, reflecting continued high levels of Chinese investment in addition to rising 

commodity prices. 

D

3

The rise in the monthly average of import unit values was 13.7 percent year-over-year in 2010, accelerating to an 

average of 14.8 percent over the first ten months of 2011, while export unit values rose an average of 2.4 percent in 

2010 and 10 percent through October in 2011.

17
its global export market share, it remains heavily dependent on exports, and it has made little 

progress in making the required shift to domestic consumption. Given that the OECD expects 

growth in domestic demand in many of China’s major export markets to continue to be slower

than in recent global recoveries, sustaining strong growth both at home and in the world will 

require China to take policy measures to increase the growth of household consumption, 

including measures that will raise household incomes and give China’s households sufficient 

confidence to spend a greater share of their incomes. Allowing RMB appreciation is a cri

part of this process. A stronger RMB directly raises the purchasing power of Chinese 

households, encouraging greater household spending. It encourages domestic investment and 

production to shift toward sectors – including services sectors – that focus on meeting C

household demand. While exchange rate reform may not be sufficient in itself to bring about a

rebalancing of the Chinese economy, rebalancing cannot take place without it. 

From June 2010, when China moved off of its peg against the dollar, through D

tical 

hinese 

ecember 16, 

011, the RMB appreciated by a total of 7.5 percent against the dollar. Because inflation in 

st 

 further appreciation – 

om China’s current account surplus, foreign direct investment (FDI), and net capital inflows –

0 GDP, or 

nths, as developments in Europe spurred an increase in 

lobal risk aversion, capital flows to emerging economies fell or even reversed, and market 

 to 

ve 

 China’s 

large increases in productivity in export manufacturing, improvements in transportation and 

 

2

China has been higher than in the United States, the RMB has appreciated more rapidly again

the dollar on a real, inflation-adjusted, basis reaching nearly 12 percent since June 2010 and 

nearly 40 percent since China first initiated currency reform in 2005. 

Even though the RMB has appreciated against the dollar, pressures for

fr

remained strong in the first three quarters of 2011. According to China’s balance of payments

data, China accumulated $373.1 billion in additional foreign exchange reserves in the first three 

quarters of 2011 — $88.8 billion more than the $284.3 billion accumulated in the first three 

quarters of 2010. The rate of reserve accumulation slowed to $92.1 billion in the third quarter of

2011 from $143 billion in the second quarter; even so, this indicates that third quarter 

accumulation averaged about $1 billion per day. The PBOC held more than $3.2 trillion in 

foreign reserves at the end of September 2011, equivalent to 54 percent of China’s 201

about $2,400 for every Chinese citizen.4

These pressures have abated in recent mo

g

expectations that Chinese authorities will continue to allow RMB appreciation under these 

circumstances have declined substantially. As firms have adjusted their behavior in response

changes in expectations and investment positions in the RMB have been unwound, there ha

been days in which the RMB fell to the bottom of its trading band, and PBOC foreign exchange 

accumulation likely has slowed significantly during the fourth quarter of 2011.5 

China’s real effective exchange rate (REER) – a measure of its overall cost-competitiveness 

relative to its trading partners – has appreciated only modestly over the past decade.

4

China has transferred (or swapped) some of its accumulated foreign exchange reserves to commercial banks, as 

well as capitalizing the China Investment Corporation (CIC), its sovereign wealth fund. China’s state sector as a 

whole – including the PBOC, state-owned banks, and CIC – holds roughly $3.7 trillion in foreign currency assets.

5

A slowdown in growth of offshore RMB deposits and changing incentives for settling export and import 

transactions in RMB, due in part to changed expectations about the extent to which Chinese authorities would allow 

the RMB to appreciate, also may have reduced the demand for China’s currency in its own foreign exchange market.   

18
logistics, and increased investment in its productive capacity all suggest that the RMB should

have appreciated significantly on a real effective basis. Yet, after China joined the WTO in 20

the RMB REER depreciated substantially, falling over 17 percent from December 2001 to 

January 2005. The REER gradually began to reverse this decline as China initiated currency 

reform in mid-2005, but was still at a similar level in early 2010 as it was at end-2001. Over the 

past few months, the REER has appreciated more rapidly, but further progress is needed. 

China’s long-standing pattern of foreign reserve accumulation, the persistence of its current 

account surplus and the incomplete appreciation of the RMB, especially given rapid producti

01 

 

vity 

rowth in the traded goods sector, indicate that the real exchange rate of the renminbi is 

 toward 

s in 

 to 

 

o 

ying to maintain trade competitiveness vis-à-vis China. Thus, greater RMB flexibility would 

f 

d services may create challenges in the short run for 

anufacturers that rely excessively on external demand, it is important to recognize that the 

 that 

g

persistently misaligned and remains substantially undervalued, though the degree of this 

undervaluation appears to have declined recently. China’s large foreign reserve accumulation 

has prolonged the misalignment in its real effective exchange rate and hampered progress

global rebalancing, including among economies that compete with China for exports. It i

China’s interest to allow the exchange rate to continue to appreciate, both against the dollar and

against the currencies of its other major trading partners. A lack of continued appreciation by 

China would prevent the exchange rate from serving as a tool to encourage consumption so as

maintain strong, sustainable growth, further complicate the adjustment needed for broader 

financial sector reform, and undermine China’s stated goal of strengthening domestic demand. 

In addition to promoting domestic demand-led growth in China, greater RMB flexibility als

would reduce incentives for excessive reserve accumulation by other Asian economies that are 

tr

further promote a strong and sustained global recovery and remove distortions from the 

international monetary system. 

While rebalancing the Chinese economy away from production of exports to provision o

domestically consumed goods an

m

longer the currency remains undervalued, the greater will be the misallocation of resources

will eventually have to be corrected. 

Japan

The yen foreign exchange market is one of the largest and most liquid in the world, accounting 

t 19 percent of the roughly $4 trillion in daily global foreign exchange transactions, 

ccording to surveys by the Bank for International Settlements (BIS). Japan maintains a floating 

g 

for abou

a

exchange rate regime, but its authorities have intervened unilaterally on two occasions this year 

to limit yen appreciation. Since a joint G-7 intervention in March 2011 to steady disorderly 

market conditions following the Tohoku earthquake and tsunami, the yen has appreciated against 

the U.S. dollar and other currencies on repatriation flows and some renewed investor appetite for

safe-haven assets, including the yen. Japanese authorities intervened on August 4, 2011, citin

speculative and disorderly exchange rate movements, buying $59 billion in foreign exchange. 

The yen depreciated by 3.5 percent against the dollar on the day of the intervention but quickly 

resumed its appreciation as investor demand for safe-haven assets continued, reaching a high of 

¥/$75.31 on October 31. The authorities intervened again on October 31, and monthly data 

released by the Japanese finance ministry for the period October 31 through November 28 

19
indicates that Japan bought approximately $116 billion in foreign exchange assets. The yen 

depreciated to ¥/$79.5 on October 31 and has appreciated to ¥/$77.9 as of December 15. 

In 2011, through mid-December, the yen appreciated by 4.1 percent against the dollar. On a 

trade-weighted basis, the yen has appreciated by 2.8 percent in 2011 through November, a

real 

nd by 

.1 percent since June. Despite this appreciation, the real value of the yen remains near its 15-

en appreciation, with a headline figure of ¥23.6 trillion ($306 

illion, or 5.0 percent of GDP). This overall figure comprises ¥2.0 trillion in fiscal spending 

-

es” 

lso 

arch. After consecutive declines in the first and second quarters of 2011, Japan’s 

al GDP grew by 5.6 percent on a seasonally-adjusted annualized basis in the third quarter, 

y 

ntal budgets to fund 

arthquake reconstruction. Japan’s government deficit widened from 3.2 percent of GDP in FY 

estic 

ng-term 

-

 and have continued to decrease 

 2011. In October 2010, the Bank of Japan (BOJ) committed to maintaining a “virtual zero 

5

year historical average. In its Article IV Report for Japan (June 2011), the IMF assessed the 

yen’s real effective exchange rate to be broadly in line with economic fundamentals. Japan’s 

foreign currency reserves increased by $189 billion in 2011 through November. Reserves are 

now at $1.22 trillion – the second-largest stock of reserves in the world behind China’s $3.2 

trillion – as a result of valuation changes on existing reserve holdings, interest earnings, and 

foreign exchange intervention. 

On October 21, the Noda Cabinet announced a package of measures to adjust to or take 

advantage of, rather than resist, y

b

measures and ¥21.6 trillion in financing measures such as loans provided by government

affiliated financial institutions. The package includes measures such as employment subsidy 

programs, SME credit guarantees, and the establishment of “special international strategy zon

designed to offer tax breaks and relaxed regulations to high-growth industrial sectors. It a

proposes to use foreign reserves in expanding a recently-announced dollar lending facility 

through the Japan Bank for International Cooperation (JBIC) to promote overseas mergers and 

acquisitions.

The Japanese economy is recovering from the earthquake, tsunami, and nuclear power plant 

disasters in M

re

driven by pent-up personal consumption and a recovery in exports with the restoration of 

earthquake-damaged supply chains. Reconstruction efforts are likely to provide a boost to 

growth in the fourth quarter and in 2012. Private consensus forecasts indicate that the econom

will contract by 0.4 percent in 2011 and then grow by 2.1 percent in 2012. 

Japan’s fiscal outlook is highly strained. Since the earthquake, the Japanese Diet has passed 

roughly ¥15 trillion in spending (about 3 percent of GDP) in three suppleme

e

2009 (April-March) to 8.0 percent of GDP in FY 2010. The deficit is expected to increase 

further in FY 2011 as a result of reconstruction spending. The IMF projects that the 

government’s gross debt will reach 233 percent of GDP in 2011. Over a longer time horizon, 

Japan will need to tackle its large fiscal deficit and public debt. Reforms to strengthen dom

demand and foster competition and productivity growth will be critical for Japan’s lo

growth and fiscal health, and will be key to meeting Japan’s commitment to contribute to the G

20 objective of strong, sustainable, and balanced global growth. 

On the monetary side, deflation remains a serious concern. Core consumer prices (excluding 

food and energy) declined by 1.2 percent year-over-year in 2010,

in

20
interest rate policy” until “price stability is in sight,” defined by the BOJ as a year-over-year 

increase in headline consumer prices ranging from 0 to 2 percent. On October 27, the BOJ 

expanded an asset purchase program established in October 2010 to “encourage the decline in 

longer-term interest rates and various risk premiums” from ¥15 trillion to ¥20 trillion. Headli

consumer prices have been mostly negative since early 2009. 

In the second quarter of 2011, Japan’s merchandise trade balance fell into deficit for the first 

time since the first quarter of 2009, at -$15.6 billion, as export

ne 

s slowed following production 

isruptions while imports increased due partly to higher commodity prices and demand for 

t 

 and 

hange rate was 

wer than in, for example, the euro-dollar market. In contrast to the G-7 joint post-earthquake 

ting 

l 

lar 

d

reconstruction materials. In the third quarter, the trade deficit narrowed to $5.4 billion, as 

exports recovered from their post-earthquake drop in March and April. Japan’s current accoun

balance has remained in surplus in 2011 to date, at 1.6 percent of GDP in the second quarter

2.2 percent of GDP in the third quarter, due to relatively stable income from overseas 

investments. Japan’s bilateral trade surplus with the United States totaled $49.9 billion in 2011 

through September, up slightly from $48.3 billion over the same period in 2010. 

The unilateral Japanese interventions were undertaken when exchange market conditions 

appeared to be operating in an orderly manner and volatility in the yen-dollar exc

lo

intervention in March, the United States did not support these interventions. It is worth no

that these operations took place at a time when foreign exchange market activity and risk 

aversion were being predominantly influenced by financial developments elsewhere in the globa

economy that were impacting all of the major currencies. Although the yen depreciated at the 

point of intervention, the exchange rate retraced its steps subsequently, leaving the yen dol

rate over four percent stronger than it was at the start of the year. Rather than reacting to 

domestic “strong yen” concerns by intervening to try to influence the exchange rate, Japan 

should take fundamental and thoroughgoing steps to increase the dynamism of the domestic 

economy, increase the competitiveness of Japanese firms – including those in utilities and

services – and raise potential growth. 

South Korea

South Korea officially maintains a market-determined exchange rate, and its authorities intervene 

 objective of smoothing won volatility. During the global financial crisis, the 

orean authorities intervened heavily to support the won, which by the fourth quarter of 2008 

an 

uthorities were net buyers of foreign exchange, except in March and June. In September, the 

r 

with the stated

K

had depreciated by 45 percent against the dollar from its 2007 peak. From early 2009 through 

2010, as global risk sentiment improved and capital flowed back into emerging markets, Kore

authorities intervened in the other direction to slow won appreciation, as well as to rebuild 

reserves, and the won remained well below its pre-crisis levels despite Korea’s strong economic

recovery and the rebound in its current account as exports recovered faster than imports. 

During 2011, Korean authorities have intervened on both sides of the market. During the first 

eight months of 2011, Korea’s foreign currency reserves rose by $18 billion as the Korean

a

authorities intervened to support the won, which had depreciated by 10 percent against the dolla

and by 3.1 percent on a real trade-weighted basis in that month alone. The won’s sharp 

depreciation was due in considerable part to generally increasing risk aversion among global 

21
investors and the unwinding of investment positions in emerging market currencies. In October, 

the won strengthened as capital inflows returned, appreciating by about 6 percent against

dollar. 

Over the course of this year, through mid-December, the won has depreciated by 3.2 percent 

against 

 the 

the dollar. Compared to its 2006-2007 average, the won remains 21 percent weaker on a 

ominal basis against the dollar, as of mid-December, and 28 percent weaker on a real effective 

n 

llion since the end of 2008 to $301 billion in November 2011. The 

ank of Korea (BOK) continues to be active in the forward market, and Korea’s net long foreign 

s, 

econd quarter, as surpluses in goods trade and income 

idened. In 2011 through November, Korea’s exports totaled $509 billion, compared to $422 

 2011 

t 

hed $189.5 billion in the 

ird quarter of 2008, before sharply declining to $149.9 billion in the fourth quarter of 2008 as 

e 

s 

ar-over-year in the first half of 2011 and 3.4 percent in the 

n

basis, as of November. According to estimates from the July 2011 IMF Article IV consultatio

with Korea, the won was undervalued by about 10 percent relative to its equilibrium level on a 

real trade-weighted basis. 

After falling by about $60 billion during the crisis, Korea’s foreign exchange reserves have 

increased by about $100 bi

B

currency/short domestic currency forward position reached $62 billion in April 2011, compared 

to -$11.1 billion in February 2009, and stood at $38 billion in November. In the last few month

Korea has expanded swap facilities with Japan and China. On October 19, the BOK expanded 

an existing won-yen swap line with the Bank of Japan to $30 billion and established a new $30 

billion swap line with Japan’s finance ministry. On October 26, the BOK and the People’s Bank 

of China agreed to double their existing RMB-KRW swap agreement to RMB 360 billion ($56.7

billion), effective for three years. 

Korea’s current account surplus was $5.4 billion (1.8 percent of GDP) in the third quarter of 

2011, up from $3.9 billion in the s

w

billion over the first eleven months of 2010 and $338 billion over the same period in 2007. 

Korea’s imports are also at record highs on a nominal U.S. dollar basis, at $479 billion in

through November. Korea’s trade surplus with the United States totaled $11.4 billion in the firs

ten months of 2011, up from $7.8 billion in the same period in 2010. 

The Korean banking system entered the crisis heavily dependent on wholesale funding, much of 

which was borrowed externally. Korea’s short-term external debt reac

th

capital inflows reversed. Short-term external debt has declined further to $138 billion as of the 

third quarter of 2011, and reserves are now more than double short-term external debt. Since lat

2008, the Korean authorities have taken a number of measures to reduce short term external debt

and the foreign exchange exposure of the financial system, including imposing caps on banks’ 

issuance of foreign currency derivatives contracts; reinstating a withholding tax on foreigners’ 

profits from Korean government bonds; and levying a tax on banks’ overseas borrowing, with 

higher rates on short-term maturity debt. In July, the authorities banned firms from purchasing 

foreign currency-denominated bonds in the domestic market that would be converted to won. 

Most recently, the authorities have proposed taxes on foreign investors’ profits from such bond

as well as from derivative products. 

The South Korean economy has recovered strongly from the global financial crisis. Although 

GDP growth slowed to 3.6 percent ye

22
third quarter because of sluggish domestic demand, due to base effects and the strong expansion 

t 

arket, 

authorities should limit 

eir foreign exchange interventions to the exceptional circumstances of disorderly market 

during 2009, Korea’s real GDP has rebounded from its 2008 decline and is currently 9.4 percen

higher than its pre-crisis level. Net exports and investment have been the main contributors to 

the Korean recovery. The government largely withdrew fiscal stimulus in 2010 and is targeting a

return to fiscal balance by 2013. Meanwhile, the Bank of Korea has been cautious in tightening 

monetary policy, despite relatively strong inflationary pressures. Headline consumer price 

inflation has been at the upper range of or exceeded the BOK’s 2-4 percent target range in the 

first three quarters of 2011, and most households expect inflation to remain above 4 percent over 

the next twelve months. Citing increased external risks, the BOK has put on hold further 

increases in the monetary policy rate, which now stands at 3.25 percent. 

Over the past two years, the Korean authorities have been active in the foreign exchange m

and the won remains weak compared to its pre-crisis levels. The Korean 

th

conditions and adopt a greater degree of exchange rate flexibility. 

Taiwan

According to its central bank, Taiwan’s exchange rate is market-determined in principle except 

asonal or irregular factors (such as massive flows of short-term capital) lead to excess 

olatility and disorderly movements in the Taiwan dollar exchange rate with adverse 

t 

ncies, the 

o 

.4 percent in the second quarter before turning negative in the third quarter, when the economy 

ojects 

ted 

ommodity and fuel prices. On June 30, the central bank raised its target rediscount rate by 12.5 

on in 

-15 

when “se

v

implications for economic and financial stability,” and the central bank intervenes “to maintain 

an orderly market.” The Taiwan dollar was little changed against the U.S. dollar in the first eigh

months of 2011, appreciating by 0.5 percent. Along with other emerging market curre

Taiwan dollar depreciated in September, falling by 5.0 percent against the dollar, and as of midDecember was 4.1 percent weaker against the dollar since the start of the year. The real effective 

exchange rate of the Taiwan dollar depreciated by 4.6 percent in the first 11 months of 2011. 

Taiwan’s real economic growth has begun to decelerate from 2010’s rapid pace of 10.8 percent. 

Real GDP rose by 9.8 percent at an annual rate in the first quarter of 2011 but growth slowed t

2

contracted by 0.6 percent, as investment declined and export growth weakened. Monthly 

indicators suggest that a further slowdown in manufacturing, exports, and consumption is likely, 

with exports growing by just 1.3 percent year-on-year in November. On December 1, the 

authorities unveiled a fiscal stimulus plan to increase investment in public infrastructure pr

and boost employment. The authorities expect real growth of 4.5 percent overall in 2011. 

Headline inflation remains low; consumer prices increased by 1.0 percent year-over-year in 

November. Government price and administrative controls have partially offset rising impor

c

basis points to 1.875 percent, the fifth hike since June 2010. The central bank cited rising 

inflation expectations and high global commodity prices for its decision, while noting 

uncertainties about U.S. growth and the debt crisis in Europe as downside risks. On September 

29, the central bank made the decision to keep its target rate unchanged. To deter speculati

the property market, on April 15, 2011, the legislature approved a new luxury tax of 10

percent on property sold within two years of purchase. 

23
Taiwan’s current account surplus narrowed in the first half of 2011 to 7.4 percent of GDP fr

9.4 percent in 2010, due in part to higher commodity im

om 

port prices. The current account surplus 

increased to 9.9 percent of GDP in the third quarter as imports declined by more than exports and 

the services surplus rose. The financial account recorded outflows of $19.2 billion in the first 

three quarters of 2011, including an outflow of $11.6 billion in the third quarter driven by a 

large-scale shift out of domestic stocks by foreign investors. Taiwan’s foreign exchange reserves 

increased by $18 billion to $400 billion during the first six months of 2011, before declining by

$12.4 billion to $388 billion at the end of November. Taiwan’s foreign exchange reserves 

amount to more than 83percent of GDP, 17 months of imports, and 3.7 times the economy’s 

short-term external debt.

Europe 

Euro Area

The value of the euro in foreign exchange markets is market-determined. The euro continues to 

nificantly against the dollar, as risk aversion associated with financial stresses in the 

uro area ebbs and flows. Attractive interest rate differentials drove the euro higher against the 

t 

 with private consumption, government 

onsumption, and net exports all contributing to growth. The rebound proved short-lived, 

ed 

 on the 

ed 

 and 

rs of 2011. 

espite the near balance in the euro area current account, substantial imbalances remain among 

fluctuate sig

e

dollar in the first four months of 2011, with the euro appreciating 9.7 percent. Amid heightened 

concerns about sovereign debt sustainability, the appreciation has been reversed, with the euro 

recording a 7.8 percent appreciation against the dollar in the first half of the year but an 11.4 

percent depreciation in the second half of the year through mid-December. On a real effective 

basis, the euro appreciated by 3.4 percent in the first half of 2011, but depreciated by 2.1 percen

in the second half of 2011through November. 

The euro area economic recovery continued in the first quarter of 2011, as the economy 

expanded by 3.1 percent on an annualized basis,

c

however, as growth slowed in the second and third quarters to 0.6 percent on an annualiz

basis. While the recession in several of the euro area program economies has been a drag

Europe’s growth for some time, the recent loss in momentum has been more broad-based: 

French growth averaged an annual rate of 0.7 percent over the past two quarters, Italy muster

only a 0.9 percent annual rate, and Germany a modestly-better 1.5 percent. Growth in the euro 

area in the fourth quarter of 2011 is now expected to be negative, as risk aversion has risen,

strains in Europe’s sovereign debt and financial markets have deepened. The European 

Commission forecasts euro area GDP to contract by 0.1 percent on a quarter-on-quarter basis in 

the fourth quarter and to register an anemic 1.5 percent growth rate for 2011 overall. 

The euro area’s current account has been close to balance over the past two years. The current 

account deficit averaged 0.5 percent of GDP in 2010 and through the first three quarte

D

euro area countries. The Netherlands and Germany continued to run substantial current account 

surpluses in 2011, while the current accounts of the other major euro area economies (France, 

Italy, and Spain) remained in deficit. Stronger domestic demand growth in surplus European 

economies would help to reduce imbalances in the euro area. 

24
25

ith 

nomies have committed to 

ducing their general government budget deficits to less than 3.0 percent of GDP by 2013, and 

compact and moved 

rward Europe’s permanent crisis response vehicle, the European Stabilization Mechanism 

nhance these efforts, including the re-activation of dollar swap lines with foreign central banks, 

e 

e 

nder 

Europe’s crisis shifted the focus of fiscal policy to deficit reduction, even in those countries w

moderate debt-to-GDP levels. Most of the major euro area eco

re

the German government announced that it would meet that target this year. 

The EU Summit agreement on October 27 required banks to meet temporarily a higher minimum

capital ratio. The Summit agreement on December 8-9 created a new fiscal 

fo

(ESM). The recent Summit agreements represent important steps forward. Continued financial 

market tensions and the scope of the related problems, however, signal that a stronger firewall is 

needed to provide a credible backstop for large, vulnerable countries and the financial sector.

The European Central Bank (ECB) continues to provide full allotments of liquidity against 

eligible collateral to euro area financial institutions. The ECB also has announced measures to

e

the provision euros and U.S. dollars at longer maturities, a €40 billion covered bond purchas

program, renewed purchases of sovereign bonds through its Securities Markets Program (SMP),

and loosening eligibility criteria on collateral. Between the resumption of SMP activity in 

August and the middle of December, SMP purchases totaled €138 billion and are believed to b

mostly Spanish and Italian sovereign bonds. After raising its main refinancing rate by 50 basis 

points earlier this year to 1.5 percent, the ECB’s early-November policy meeting (the first u

new ECB President Mario Draghi) led to a 25 basis point cut. Citing intensified risks to growth, 

the ECB reduced the main refinancing rate by an additional 25 basis points to 1.0 percent on 

December 8. 

Switzerland

The Swiss franc usually has been a freely floating currency, and the Swiss National Bank (SNB) 

 policy to keep inflation stable at around 2 percent. Appreciation of the franc, 

articularly against the euro, became an urgent concern for the SNB during the second quarter of 

llar 

n the economy and raising deflation risks. Inflation was 0.2 percent in August, 

n a year-over-year basis, well-below the SNB’s 2 percent target. The SNB responded to the 

On 

sets monetary

p

2011. The franc depreciated by 5.2 percent against the euro through early April, but reversed 

course thereafter, appreciating by 8.7 percent from April 8 to the end of June. Against the do

the franc appreciated by 10 percent in the first half of 2011, and it appreciated by 7.0 percent on 

a real effective basis. The pace of appreciation of the franc against the euro accelerated in the 

third quarter, particularly as concerns about the crisis in Europe rose and risk aversion increased. 

Between the end of June and August 11, the franc appreciated very sharply, by 16.9 percent 

against the euro. 

The SNB expressed increasing concern that the appreciation against the euro was having 

negative effects o

o

appreciation by flooding the market with liquidity and driving interest rates to near zero. 

August 3, the SNB lowered the upper limit of its target range for the three-month Libor to 0-0.25 

percent (from 0-0.75 percent). On August 10, the SNB announced additional measures to 

increase liquidity and reduce the appreciation of the franc. These included pumping more 

liquidity into the Swiss money market and conducting foreign exchange swap transactions (a 

policy last used in late 2008). The franc nonetheless continued to strengthen. 
26

se comments 

sulted in a 4.5 percent depreciation of the franc against the euro the following day. The franc 

. 

ceiling. 

e financial stresses in Europe, 

sulting in disorderly movements in the exchange rate. 

t to $317 billion, reflecting the 

plementation of currency swaps and possibly direct intervention. Reserves subsequently 

ecline 

nt with a 

ilize 

ally robust export and services-driven economy. After posting 3.1 percent 

DP growth in 2010, growth slowed steadily from an annual rate of 2.3 percent in the first 

nd 

On August 11, an SNB official said that a temporary peg to the euro was within the range of 

options that policy makers could use to stem the appreciation of the franc. The

re

continued to depreciate through August, but by early September started moving upward again

As a result, on September 6, the SNB announced that it was establishing a ceiling on the 

euro/franc exchange rate. The franc would not be allowed to appreciate beyond 1.20 francs per 

euro. The SNB said it was “... aiming for a substantial and sustained weakening of the Swiss 

franc,” and was prepared to buy foreign currency in “unlimited quantities” to enforce the 

Following the September 6 announcement, the franc depreciated by 7.9 percent against the euro,

the largest one-day depreciation of the franc since the creation of the euro. Through midDecember, the franc had depreciated by 9.8 percent against the euro and 17.7 percent against the 

dollar, and the exchange rate had not breached the 1.20 franc threshold despite the lack of 

intervention indicated by Swiss foreign exchange reserves. 

The circumstances prompting the actions by the SNB are unique to Switzerland. It is a small 

open economy that has been disproportionally affected by th

re

Switzerland’s foreign exchange reserves rose by 6.9 percent ($15.1 billion) in the first six 

months of 2011. In August, reserves rose by 35.5 percen

im

declined during the next three months to reach$252 billion by the end of November. The d

reflects the unwinding of currency swaps and the depreciation of the euro and is consiste

lack of intervention to prevent the appreciation of the franc. The SNB typically does not ster

its interventions. 

Slower global growth, events in the euro area, and appreciation of the franc are beginning to take 

their toll on the usu

G

quarter of 2011 to 1.3 percent in the third quarter, and a worse performance is forecast for the 

fourth quarter. GDP growth for the full year is forecast to be about 1.7 percent. Deflation 

remains a threat. Consumer prices fell by 0.1 percent in October on a year-over-year basis a

by 0.5 percent in November. 

United Kingdom

The United Kingdom (UK) has a freely floating market-determined exchange rate. The pound 

inst the dollar in 2011 through early December. However, the currency 

ppreciated by 6.6 percent through the end of April before giving up much of these gains to 

r 

eal 

d by 

was unchanged aga

a

finish the first half of the year up 2.8 percent against the dollar. Since then, the pound has 

continued to depreciate against the dollar, falling by 3.5 percent in the second half of the yea

through mid-December, as recent surveys and data indicate that growth is weakening. On a r

effective basis, the pound depreciated by 1.7 percent in the first half of 2011, but appreciate

2.8 percent in the second half through November, reflecting the pound’s nominal depreciation 

against other currencies excluding the dollar, notably the euro, and a continued positive inflation 

differential. 
27

ary effects of bad weather – real GDP rebounded in the first quarter of 2011, 

rowing by 1.6 percent. Growth slowed to 0.4 percent on an annualized basis in the second 

nomy 

0.7 

eductions. This austerity package, 

nnounced by the government in June 2010, was originally projected by 2014-15 to: 1) bring the 

t of 

cent and, at its October meeting, increased the size of its 

uantitative easing program to £275 billion from £200 billion, citing the weaker global 

ld 

increases 

After contracting by 2.0 percent on an annualized basis in the fourth quarter of 2010 – due in part 

to the tempor

g

quarter, before recovering in the third quarter to 2.0 percent. The recovery has been weighed 

down this year as consumption, investment, and exports – which previously buoyed the eco

– have fallen sharply. As a result, the UK’s Office of Budget Responsibility (OBR) recently 

lowered its growth forecasts from 1.7 percent to 0.9 percent for 2011, and from 2.5 percent to 

percent for 2012. The UK’s current account deficit narrowed to 0.5 percent of GDP in the 

second quarter of 2011, down from 1.1 percent of GDP in the first quarter and 2.5 percent of 

GDP in 2010, as falling imports improved the trade deficit. 

The coalition government that formed after the May 2010 elections has committed to an 

accelerated reduction in the fiscal deficit, led by expenditure r

a

cyclically adjusted current budget into balance; 2) reduce the budget deficit to 3.0 percen

GDP; and, 3) put the gross debt-to-GDP ratio on a declining path. Under updated OBR growth 

forecasts, the government will not meet the first two objectives until 2016-17, and debt-to-GDP 

will not start to fall until 2015-16. 

Monetary policy remains accommodative. The Bank of England (BOE) has maintained its 

historically low policy rate at 0.5 per

q

environment, renewed bank funding strains, and ongoing drag from both weak real househo

incomes and fiscal tightening. Inflation has remained above the BOE’s 2.0 percent target for 

close to two years and has been driven primarily by rising energy and import prices and 

in the value-added tax in 2010 and 2011. The BOE expects inflation to decline next year as 

these effects diminish. 

Western Hemisphere 

Brazil

Brazil operates under a floating exchange rate regime, although the central bank intervenes 

y and controls on capital inflows became increasingly important in the first half of the 

ear as the authorities attempted to contain appreciation of the real. The real appreciated by 5.4 

llar 

lf 

lue. 

eavily on purchases of 

regularl

y

percent against the dollar in the first half of 2011 and reached its highest level against the do

in over a decade at the end of July before a sharp depreciation in September. For the second ha

of the year, through early December, the real has depreciated by 19.5 percent against the dollar. 

The real effective exchange rate followed a similar pattern, with the real appreciating by 4.8 

percent in the first half of the year but declining by 8.1 percent in the second half through 

November. In its fall 2011 World Economic Outlook (WEO), the IMF indicted that the real 

effective exchange rate of the real was overvalued relative to its medium-term equilibrium va

The subsequent depreciation likely has lessened the overvaluation. 

Preventing significant appreciation of the real was a priority for the Brazilian government in the 

first three quarters of this year. Central bank intervention focused h
28

ollars in spot markets for foreign exchange. Through the end of September, the central bank’s 

ut 

on. 

owdown and recent weakening of the real. Through July 2011, the authorities repeatedly 

, but 

s and 

9. Local analysts surveyed by the central bank 

ow expect growth to be 3.1 percent in 2011. Strong growth in the first half of the year was led 

ral bank’s target band of 4.5 percent ± 2 

ercent. High core and services inflation (7 percent and 9 percent, respectively) indicate excess 

 of GDP 

quarter of 2011. Brazil’s trade deficit with the United States rose to $6.0 billion in 

e first half of 2011 from $5.0 billion in the same period of 2010. 

d

purchases of dollars in spot markets averaged $5.3 billion per month. Subsequently, in response 

to the significant depreciation of the real in September, the central bank sold dollars in the 

forward market for the first time in over two years. The central bank made only limited spot 

dollar purchases in September and did not intervene in the spot markets at all in October and 

November. Foreign exchange reserves increased by $68.1 billion in 2011 through August b

fell $2.4 billion over the next three months. At the end of November, reserves were $342 billi

Brazil implemented a series of measures to limit capital inflows and upward pressures on the 

exchange rate in the first half of the year, which are starting to be unwound given the economic 

sl

broadened the scope of the six percent financial operations tax (IOF) on capital inflows and 

introduced additional measures to limit short U.S. dollar positions. Net financial inflows 

remained large for much of the year (averaging $12.2 billion per quarter through September)

have decreased in the fourth quarter. In light of reduced inflows and real depreciation, the 

government removed the IOF (Imposto sobre Operaçoes Financeiras) tax on equity inflow

long-term bond purchases in early December 

Strong economic growth of 7.5 percent in 2010 closed the remaining estimated output gap from 

Brazil’s sharp but short recession in 2008-200

n

by household consumption growth, as a tight labor market has led to higher real wages. Growth 

slowed in the second half of the year, however, due to the lagged effects of monetary policy 

tightening and weakness in the industrial sector (partly explained by imports from abroad 

meeting an increasing share of private sector demand). 

Inflation declined from 7.3 percent on a year-over-year basis in September to 6.6 percent in

November, but remains above the upper limit of the cent

p

demand and potential overheating. Nonetheless, after tightening monetary and fiscal policy 

during the first half of 2011, the central bank began cutting its policy rate in August by 50 bps 

for three consecutive months, bringing it to 11.0 percent in November, noting that the adverse 

global environment is likely to create significant external headwinds and disinflationary 

pressures. 

Brazil’s current account deficit narrowed from 2.2 percent of GDP in 2010 to 2.0 percent

in the third 

th

Canada

Canada maintains a flexible exchange rate. The Canadian dollar appreciated by 3.4 percent 

against the U.S. dollar in the first half of 2011 but depreciated by7.4 percent against the dollar in 

the second half of the year through mid-December. On a real effective basis, the Canadian dollar 

appreciated by 0.7 percent in the first half of the year but depreciated by 3.1 percent in the 

second half through November. The appreciation of the Canadian dollar during the first half of 

the year was supported by high commodity prices as well as the expectation that the Bank of 
29

n 

y 0.5 percent in the second quarter. In the second quarter, 

omestic demand growth remained positive but Canada experienced a sharp decline in net 

ted 

 

ices 

 the third quarter. Imports have strengthened throughout the first three quarters of the year, as 

 end 

its policy 

te at 1.0 percent since September 2010, citing subdued core inflation and, more recently, 

Canada would raise interest rates well ahead of the Federal Reserve. The recent depreciatio

reflects a reversal of commodity prices as well as a deterioration in Canada’s economic outlook, 

driven largely by external factors. 

The Canadian economic recovery continued in the first half of 2011. Real GDP expanded by 3.5 

percent in the first quarter but fell b

d

exports, driven in large part by increased imports of capital goods. Exports to the United States, 

Canada’s main trading partner, fell in the second quarter but rebounded in the third quarter. 

Overall growth was 3.5 percent in the third quarter and Canada’s economic outlook is expec

to track the U.S. economy in the near-term. The Bank of Canada forecasts growth to moderate to

2.1 percent in 2011 and 1.9 percent in 2012. In 2011, investment has been the main driver of

domestic demand, as historically high commodity prices encourage greater production in 

Canada’s resource-rich provinces. Personal consumption growth stalled in the first quarter but 

picked up again (modestly) in the second and third quarters. Going forward, authorities expect

relatively high household debt levels to limit the pace of growth in personal consumption.

Exports were supported in the first half of 2011 by strong commodity prices, despite the second

quarter decline in exports to the United States. Exports declined due to lower commodity pr

in

the rising Canadian dollar boosted purchasing power and as firms increased their purchase of 

capital goods to support rising investment. Canada’s current account deficit widened to 3.6 

percent of GDP in the second quarter and was 2.8 percent of GDP in the third quarter. 

The government has continued fiscal consolidation in pursuit of overall fiscal balance by the

of FY2014, from a 2.7 percent deficit in FY2010. The Bank of Canada has maintained 

ra

growing concern about the external outlook. The Bank of Canada’s target for inflation is 2 

percent. Headline inflation has decelerated to 2.9 percent on a year-over-year basis in October 

2011, down from 3.7 percent in May, with core inflation of 2.1 percent. 

Mexico

Mexico has a flexible exchange rate and employs an inflation-targeting monetary policy regime. 

 effective basis, the peso appreciated by 0.5 percent during the first half of 2011 but 

eclined by 11.1 percent in the second half of the year through November. Against the dollar, 

t 

wned oil company, 

emex. Mexico also continued its explicit strategy of reserve accumulation whereby the central 

eso 

t 

On a real

d

the peso appreciated by 5.1 percent during the first half of 2011 but fell by 18.8 percent during 

the second half of 2011 through mid-December on rising risk aversion. 

Mexico’s foreign reserves increased by 6.7 percent to $123 billion in the first half of 2011. Mos

of this increase was driven by foreign exchange inflows from the state-o

P

bank auctions up to $600 million in options per month to banks, which allows them to sell 

dollars to the central bank at the previous day’s exchange rate any day in the month that the p

appreciates above its 20-day average. While options sales are small relative to Pemex flows, the

strategy allows the bank to accumulate reserves and “lean against the wind” in a transparen

rules-based framework. On November 29, 2011, citing international developments and the need 
30

cy 

an 

ne. 

hird quarter growth was 5.5 percent. Oil production was flat in 2010 and the first half of 2011, 

n was 3.5 percent in 

ctober on a year-over-year basis, in the upper part of the central bank’s target band (2.0-4.0 

 of 

n the third quarter. Rising oil export prices have been offset to a large degree by the rising 

ost of gasoline imports from the United States, while strong manufacturing export growth has 

to maintain the orderly functioning of the foreign exchange market, Mexico temporarily 

suspended its monthly option auctions. Mexican authorities also announced a temporary poli

of auctioning $400 million in foreign exchange on any day in which the peso depreciates by 

more than 2 percent from the previous day’s close. In December 2010, Mexico obtained 

augmented precautionary Flexible Credit Line (FCL) from the IMF equivalent to $72 billion, up 

from $48 billion previously. As of the end of October 2011, Mexico had not drawn on this li

Real GDP expanded by 2.3 percent in the first quarter of 2011 and by 5.2percent in the second 

quarter. Private consumption and investment drove economic growth in the first half of 2011. 

T

while manufacturing production has shown strong growth throughout most of 2011 (excluding 

the short-lived supply disruptions following Japan’s earthquake). 

The central bank has maintained an accommodative monetary policy stance since the crisis, 

keeping its target interest rate at 4.5 percent since July 2009. Inflatio

O

percent). Core inflation was 3.3 percent in October, but is down somewhat from the previous

year. 

Mexico’s current account deficit was 0.8 percent of GDP in the second quarter and 1.0 percent

GDP i

c

been offset by rising volumes and prices of commodities and other imports. Exports to the 

United States grew by 9.1 percent during 2011 through October, while imports from the United 

States grew by 18.7 percent. 

 
Glossary of Key Terms in the Report 

Bilateral Real Exchange Rate – The bilateral exchange rate adjusted for inflation in the two 

countries, usually consumer price inflation. 

BIS Effective Exchange Rate– An effective exchange rate index calculated as a geometric 

weighted average of bilateral exchange rates. The weights are based on manufacturing trade 

flows and capture both bilateral export and import trade and export competition in third markets. 

To capture changes in trade patterns over time, the weights are time-varying. 

Exchange Rate– The price at which one currency can be exchanged for another. Also referred 

to as the bilateral exchange rate. 

Exchange Rate Regime –The manner or rules under which a country manages the exchange rate 

of its currency, particularly the extent to which it intervenes in the foreign exchange market. 

Exchange rate regimes range from floating to pegged. 

31

hich 

or 

2011 Weights in the Federal Reserve Dollar Indexes

Currency of Broad Index Major Index OITP Index

Euro area 16.36 36.54

Canada 13.23 29.56

Japan 7.80 17.41

Mexico 11.45 20.73

China 19.76 35.77

United Kingdom 3.54 7.91

Taiwan 2.60 4.71

Korea 3.86 6.99

Singapore 2.04 3.69

Hong Kong 1.31 2.37

Malaysia 1.84 3.32

Brazil 2.07 3.74

Switzerland 1.68 3.76

Thailand 1.45 2.63

Philippines 0.60 1.09

Australia 1.31 2.94

Indonesia 1.11 2.01

India 1.78 3.21

Israel 1.09 1.97

Saudi Arabia 0.81 1.46

Russia 1.12 2.02

Sweden 0.84 1.88

Argentina 0.57 1.03

Venezuela 0.40 0.72

Chile 0.78 1.42

Colombia 0.62 1.12

Source:  Federal Reserve Board

Federal Reserve Dollar Indexes – The Federal Reserve 

calculates three effective exchange rate indexes for the 

dollar. All are weighted averages of the foreign exchange 

value of the dollar against a group of currencies. The 

weights are time-varying and are based on U.S. export 

shares, U.S. import shares, and export competition in third 

markets. The Broad index includes the 26 currencies used 

by the major trading partners of the United States. This 

index is then split into a Major currency index and an Other 

Important Trading Partner (OITP) index. The Major 

Currencies Index includes seven currencies that are used 

widely in international transactions (the euro, yen, pound 

sterling, Australian dollar, Canadian dollar, Swiss franc, and 

Swedish krona). The OITP Index includes 19 emerging 

market currencies. Although these currencies are used by 

major trading partners of the United States, they do not 

circulate widely internationally. Current weights are given in 

the table to the right. For weights in all years see: 

http://www.federalreserve.gov/releases/H10/Weights/ 

Floating (Flexible) Exchange Rate – A regime under w

the foreign exchange rate of a currency is fully determined 

by the market with intervention from the government 

central bank being used sparingly. 

International Reserves– Foreign assets held by the central bank that can be used to finance the 

balance of payments and for intervention in the exchange market. Foreign assets consist of gold, 

Special Drawing Rights (SDRs), and foreign currency (most of which is held in short-term 

government securities). The latter are used for intervention in the foreign exchange markets. 
32

Intervention – The purchase or sale of a country’s currency in the foreign exchange market by a 

government entity (typically a central bank) in order to influence its exchange rate. Purchases 

involve the exchange of a country’s foreign currency reserves for its own currency, reducing 

foreign currency reserves. Sales involve the exchange of a country’s own currency for a foreign 

currency, increasing its foreign currency reserves. Interventions may be sterilized or 

unsterilized.

Managed Float– A regime under which a country establishes no predetermined path for the 

exchange rate but the central bank frequently intervenes to influence the movement of the 

exchange rate against a particular currency or group of currencies. Some central banks explain 

this as a policy to smooth fluctuations in exchange markets without changing the trend of the 

exchange rate. 

Nominal Effective Exchange Rate (NEER) – A measure of the overall value of a currency 

relative to a set of other currencies. The effective exchange rate is an index calculated as a 

weighted average of bilateral exchange rates. The weight given to each country’s currency in the 

index typically reflects the amount of trade with that country. 

Pegged (Fixed) Exchange Rate – A regime under which a country maintains a fixed rate of 

exchange between its currency and another currency or a basket of currencies. Typically the 

exchange rate is allowed to move within a narrow predetermined (although not always 

announced) band. Pegs are maintained through a variety of measures including capital controls 

and intervention. 

Real Effective Exchange Rate (REER) – The effective exchange rate adjusted for relative 

prices, usually consumer prices. 

Sterilized intervention – An action taken by the central bank to offset the effect of intervention 

on the domestic money supply. Intervention in which the central bank sells domestic currency 

increases the domestic money supply, and is, in essence, expansionary monetary policy. To 

neutralize the effect of the intervention on the money supply, the central bank will sell domestic 

government securities, taking an equivalent amount of domestic currency out of circulation. If 

the intervention involved the purchase of domestic currency, the central bank will buy 

government securities, placing an amount of domestic currency equivalent to the size of the 

intervention back into circulation. An intervention is partially sterilized if the action by the 

central bank does not fully offset the effect on the domestic money supply.

Trade Weighted Exchange Rate – see Nominal Effective Exchange Rate 

Unsterilized Intervention –The purchase of domestic currency through intervention in the 

exchange market reduces the domestic money supply, whereas the sale of domestic currency 

through intervention increases the money supply. If the central bank takes no action to offset the 

effects of intervention on the domestic money supply, the intervention is unsterilized.