Report to Congress on International

Economic and Exchange Rate Policies

U.S. Department of the Treasury

Office of International Affairs

May 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......................................................................................................................... 4

U.S. MACROECONOMIC TRENDS ......................................................................................... 4

THE GLOBAL ECONOMY ........................................................................................................ 6

U.S. INTERNATIONAL ACCOUNTS ..................................................................................... 10

THE DOLLAR IN FOREIGN EXCHANGE MARKETS...................................................... 11

ANALYSES OF INDIVIDUAL ECONOMIES ....................................................................... 12

ASIA ........................................................................................................................................................................12

China..................................................................................................................................................................12

Japan..................................................................................................................................................................15

South Korea........................................................................................................................................................17

Taiwan................................................................................................................................................................18

EUROPE ...................................................................................................................................................................19

Euro Area...........................................................................................................................................................19

Switzerland.........................................................................................................................................................20

United Kingdom.................................................................................................................................................21

WESTERN HEMISPHERE ...........................................................................................................................................22

Brazil..................................................................................................................................................................22

Canada...............................................................................................................................................................23

Mexico................................................................................................................................................................24

GLOSSARY OF KEY TERMS IN THE REPORT ......................................................................... 25

 

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 second half of 2010, and data as available through the first four months of 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 this Report. 

The U.S. economy is recovering from its deepest recession in the post war period. The recovery 

is being led by private demand, as personal consumption and business investment are increasing 

while government support for the economy is receding. Over the last seven quarters personal 

consumption has increased by 2.2 percent at an annual rate and business investment in capital 

equipment has grown by 13.9 percent. The private sector has added more than 2 million jobs 

over the last 14 months. The positive outlook for the remainder of 2011 and for 2012 reflects 

growing momentum in these sustainable sources of private demand. 

While recent growth is encouraging, the economy still faces significant challenges. The severe 

effects of the recent recession are particularly apparent in the labor market and in the housing 

market, and our long-term fiscal position is unsustainable. 

The global economic recovery continues to gain strength, although risks remain. Global output 

expanded by 5 percent in 2010, after a contraction of 0.5 percent in the previous year. Advanced 

economies grew in the aggregate by 2.9 percent in 2010 while emerging market and developing 

economies (EMEs) grew 7.2 percent, led by developing Asia with a growth rate of 9.5 percent. 

EMEs benefitted significantly from the recovery in global trade, as exports by non-fuel exporting 

EMEs increased 19 percent. 

The recovery faces a number of significant challenges. In Europe, leaders face a set of difficult 

choices over how to resolve pressures on their sovereign debt markets. Commodity prices have 

risen by nearly 35 percent over the past twelve months, leaving consumers with less money to 

spend. Inflation is accelerating in many fast growing emerging economies, leading them to 

tighten monetary policy. The G-20 needs to advance efforts to prevent the re-emergence of 

persistently large current account surpluses and deficits. Advanced countries need to take steps 

to put their public finances on sustainable trajectories. Finally, higher growth and rates of return 

in emerging economies are attracting significant inflows of foreign capital. 

With respect to exchange rate policies, ten economies were reviewed in this Report, accounting 

for nearly three-fourths of U.S. trade. Many of the economies have fully flexible exchange rates. 

A few have more tightly managed exchange rates, with varying degrees of management. This 

Report highlights the need for greater exchange rate flexibility, most notably by China, but also 

in other economies. 

2
In China, since the authorities decided in June 2010 to allow the exchange rate to appreciate in 

response to market forces, the renminbi (RMB) has appreciated by a total of 5.1 percent against 

the dollar in nominal terms through the end of April 2011, or at an annual pace of approximately 

6.0 percent. Because inflation in China is significantly higher than it is in the United States, the 

renminbi has appreciated more rapidly against the dollar on a real, inflation-adjusted basis, at a 

rate of around 9 percent per year. A more rapid pace of nominal appreciation would enable 

China to achieve the needed adjustment in the real value of its currency while simultaneously 

reducing inflationary pressures in its domestic economy. China’s international reserves have 

risen by $197 billion over the first quarter of 2011. 

That continued rapid pace of foreign reserve accumulation in China; the broadly unchanged level 

of China’s real effective exchange rate, especially given rapid productivity growth in the traded 

goods sector; and the projected widening of current account surpluses, all indicate that the real 

effective exchange rate of the renminbi remains substantially undervalued. It is in China’s 

interest to allow the nominal exchange rate to appreciate more rapidly, both against the dollar 

and against the currencies of its other major trading partners. By trying to limit the pace of 

appreciation, China is not allowing the exchange rate to serve as a tool to counter inflation in its 

own economy. The policy complicates the adjustment needed for broader financial sector 

reform. It works against China’s stated goal of strengthening domestic demand. And it places an 

undue burden of adjustment on other emerging market economies that maintain more flexible 

exchange rate systems and that have already seen substantial exchange rate appreciation. 

There has been increasing recognition of the role of exchange rate appreciation in addressing 

inflation in China. On April 19, People’s Bank of China Deputy Governor Hu Xiaolian stated 

that China should “increase exchange rate flexibility to ease imported inflation pressures,” and in 

comments to China’s State Council in April, Premier Wen noted that “strengthening the 

flexibility” of the exchange rate can serve as one of the tools available to control inflation. 

During the recent Strategic and Economic Dialogue (S&ED), China stressed that it “will 

continue to promote RMB exchange rate flexibility.” 

Based on the ongoing appreciation of the renminbi against the dollar since June 2010, China’s 

public statements asserting that it will continue to promote RMB exchange rate flexibility, and 

China’s recent policy commitments through the G-20 and the S&ED to address external 

imbalances, 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. Treasury’s 

view, however, is that progress thus far is insufficient and that more rapid progress is needed. 

Treasury will continue to closely monitor the pace of appreciation of the renminbi by China. We 

will continue to encourage China to open markets and to pursue policies that level the playing 

field and support a shift to domestic-demand led growth. 

It is a high priority for Treasury, working through the G-20, the IMF, and through direct bilateral 

discussions to encourage policies that will produce greater exchange rate flexibility. 

3
Introduction 

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

half of 2010. Where pertinent and when available, data and developments through April 2011 

are included. 

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

discussed in this report accounted for 73 percent of U.S. merchandise trade in 2010. 

U.S. Macroeconomic Trends 

The ongoing economic recovery gained momentum at the end of 2010. Real GDP growth 

accelerated in the fourth quarter, led in part by the fastest pace of consumer spending in four 

years, and private-sector hiring picked up. Although the pace of expansion slowed in the first 

quarter of 2011, the recovery remains on firm footing. Consumer spending continued to grow, 

business investment in equipment and software accelerated, job growth picked up, and factory 

output rose at a rapid rate. These developments, along with generally positive business survey 

data, suggest the underlying trend in economic activity is solid. Even so, risks remain. The 

unemployment rate remains very high at 9.0 percent, and the housing sector continues to be a 

point of weakness. Home sales and residential construction are being held back by a number of 

factors, including excess supply, tight lending standards, uncertainty about future house prices, 

and the high level of unemployment. The recent run-up in oil prices is also a concern, as higher 

fuel prices reduce consumer purchasing power and increase business costs. Despite these risks, 

the outlook for the remainder of 2011 is positive. Private forecasters expect growth to strengthen 

in the second quarter, with real GDP growth projected to grow by 3 to 3.5 percent through the 

end of the year. 

The U.S. Economy Continued to Grow in Early 2011 

Real GDP growth moderated from a 3.1 percent annual rate at the end of 2010 to a 1.8 percent 

annual rate in the first quarter of 2011 – the seventh straight quarter of growth since the economy 

emerged from recession in mid-2009. The slowdown appears to have been driven in part by 

temporary factors, including severe winter weather early in the quarter that curtailed construction 

spending. Business investment in structures fell sharply, extending a trend that began in mid2008 and pulling business construction expenditures down to their lowest level since 1978. 

Residential investment also edged lower in the first quarter and is now at a 28-year low. 

Housing activity has been essentially neutral for growth since mid-2009, shaving less than 

0.1 percentage point, on average, off of real GDP growth from the third quarter of 2009 through 

the first quarter of 2011. In the previous 3.5 years, residential investment reduced growth by an 

average of 1 percentage point per quarter. 

Consumer spending moderated to a 2.2 percent annual rate from the prior quarter’s rapid 

4.0 percent pace, which was the fastest quarterly increase since 2006. The trade deficit widened 

slightly in the first quarter as imports rose faster than exports. This shaved 0.1 percentage point 

off of real GDP growth, a distinct shift from the fourth quarter when trade boosted growth by 

more than 3 percentage points. A drop in government spending, led by a large decline in federal 

defense outlays, cut another 1.1 percentage points off the first-quarter growth rate. 

4
On the plus side, business investment in equipment and software accelerated in the first quarter 

to a solid 11.6 percent annual rate, and firms accumulated inventories at a faster rate than in the 

fourth quarter, boosting real GDP growth by 1.2 percentage points. Private domestic final 

demand (the sum of consumer spending and private fixed investment) rose 2.2 percent in the first 

three months of 2011, substantially less than the 4.4 percent increase posted in Q4 but still 

indicative of reasonable momentum from sustainable sources of demand. Since the current 

expansion began in mid-2009, real GDP has risen by 4.9 percent, more than reversing the 

4.1 percent drop in output during the recession. 

The Housing Sector Remained Weak 

Housing activity remained depressed at the start of 2011. Housing starts picked up in the first 

quarter but fell sharply in April, approaching the record low level posted two years earlier. New 

single-family home sales dipped to a new low in February and, despite gains in March and April, 

remained at a historically low level. Sales of existing homes (single-family as well as condos 

and co-ops) have trended up since last summer, when they dropped sharply following the 

expiration of the home buyer tax credit, but at the start of the second quarter were still about 13 

percent below the levels recorded in the spring of 2010, when the tax credit boosted housing 

demand. Mortgage rates have risen from the record low levels recorded last fall but remain 

attractive. Freddie Mac’s benchmark measure for a 30-year fixed rate mortgage remained in a 

narrow band between 4.75 and 5 percent during the first quarter but has since eased to around 4.6 

percent. Low mortgage rates are lending support to housing demand but a number of other 

factors, including relatively tight lending standards, are weighing on demand. 

Although the inventory of homes available for sale has fallen a great deal over the past several 

years, it remains very high relative to sales. At the end of April there was a 6.5-month supply of 

new homes on the market and a 9.2-month supply of existing homes. The average prior to the 

housing bubble (2000-2004) was around 4 months for new homes and 4.5 months for existing 

homes. The large stock of homes currently on the market is holding back new construction and 

putting downward pressure on house prices. After several months of improvement, house prices 

started to decline again in late 2010. The S&P/Case-Shiller 20-city house price index turned 

slightly lower on a year-over-year basis in October and declines have accelerated since then. In 

February, this measure was 3.3 percent below its year-earlier level. That was the largest 12-

month decline since late 2009. Similarly, the FHFA house price index fell 5.9 percent over the 

year ending in March, the biggest 12-month drop since May 2009. 

Labor Market Conditions Improved 

The labor market recovery strengthened notably in early 2011. Payroll job growth accelerated in 

the first quarter, with private firms adding an average of 188,000 jobs per month – the most in 

five years. Roughly 2.1 million private-sector jobs have been created since firms began hiring 

steadily again in February 2010. The unemployment rate has fallen by 0.8 percentage point 

since November and in April stood at 9.0 percent. The drop in the jobless rate was due in large 

part to strong employment growth. The labor force participation rate fell from 64.5 percent in 

November 2010 to a 27-year low of 64.2 percent in January 2011, but has held steady at that 

level through April. 

5
Despite these gains, private employment is still 6.7 million lower than at the start of the recession 

in December 2007 and the unemployment rate is 4 percentage points higher. In addition, longterm unemployment (the share of the unemployed out of work for 27 weeks or more) remains 

very high at 43.4 percent – close to its May 2010 peak of 45.6 percent. 

Energy Prices Rose Sharply 

Energy prices have risen sharply since the beginning of the year. The front-month futures 

contract for West Texas Intermediate crude 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 climbed82 cents (or 26 percent) to $3.96 per gallon. 

Core Inflation Remained Low 

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

higher in early 2011. However, core inflation remained subdued, reflecting the large degree of 

slack in labor markets and low level of capacity utilization. The consumer price index rose 

3.2 percent over the year ended in April, up from a 2.2 percent increase during the year ended in 

April 2010. Core consumer prices (excluding food and energy) rose 1.3 percent over the year 

ended in April 2011, compared to 0.9 percent over the same period a year earlier. Growth of 

compensation costs remained contained in the first quarter. The Employment Cost Index (ECI) 

for private-industry workers rose 2 percent over the year ending in March. Recent year-overyear gains in this measure are among the smallest in the 30-year history of the data series. 

Fiscal Consolidation is a Priority 

With the recovery of the U.S. economy firmly in place, fiscal consolidation is a high priority. 

The U.S. government’s fiscal position is projected to improve significantly over the next few 

years as the economy recovers and as the emergency measures taken during the recession expire. 

However, even with these improvements, deficits will remain too high, and our debt will 

continue to grow relative to the size of our economy. 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 mid-April, President Obama proposed a plan to reduce the budget deficit by 

$4 trillion over the next 12 years and put the debt on a declining path as a share of the economy 

by the second half of the decade. Deficit reduction in the President’s plan is phased in over time 

to protect and strengthen our economic recovery and the labor market. A debt “failsafe” would 

trigger across-the-board spending reductions if, by 2014, the projected debt-to-GDP ratio is not 

declining toward the end of the decade. A comprehensive and balanced fiscal reform plan will 

safeguard our economy and ensure we have the ability to invest in our future.

 

The Global Economy 

The global economy recovered strongly in 2010, growing 5.0 percent compared to a contraction 

in output of 0.5 percent in 2009, according to the IMF. The pace of the recovery across 

economies, however, was uneven, with the advanced economies expanding by an estimated 3.0 

6
percent in the aggregate and emerging market and developing economies growing by 7.3 percent 

in the aggregate. The economies of the G-7 countries grew by 2.8 percent in 2010, whereas the 

emerging market and developing economies in Asia grew a collective 9.5 percent. 

 

In many advanced economies, growth has 

been too slow to make much headway 

against continuing high levels of 

unemployment, which in March 2011 

stood at 9.9 percent in the euro area, 4.6 

percent in Japan, and 8.8 percent in the 

United States. In the United Kingdom, 

the latest unemployment data are for 

February when the rate was 7.7 percent. 

Only two of the G-7 advanced economies 

(Canada and the United States) had 

returned to their pre-crisis levels of 

economic output by the end of 2010, and 

few have erased the employment losses 

suffered during the crisis. 

88

90

92

94

96

98

100

102

Q3‐2007Q4‐2007Q1‐2008Q2‐2008Q3‐2008Q4‐2008Q1‐2009Q2‐2009Q3‐2009Q4‐2009Q1‐2010Q2‐2010Q3‐2010Q4‐2010

Real GDP, index pre‐crisis peak = 100

Canada France Germany Italy

Japan U.K. U.S.

85

90

95

100

105

110

115

120

125

Q1‐2008Q2‐2008Q3‐2008Q4‐2008Q1‐2009Q2‐2009Q3‐2009Q4‐2009Q1‐2010Q2‐2010Q3‐2010Q4‐2010

Real GDP, index pre‐crisis peak = 100

Brazil China

Korea Mexico

In contrast, by the end of 2010, real GDP 

in all the emerging market economies 

discussed in this Report had exceeded precrisis levels.2

 These economies have 

benefited from the recovery in global 

trade. Exports by non-fuel exporting 

emerging market economies rose by 19 

percent, well above their 2003-07 average 

of 12.5 percent. 

Taiwan

Note:  China'sreal GDP neverdeclined

Global financial conditions generally improved throughout 2010, although there were marked 

disruptions in the late spring resulting from severe strains in sovereign debt markets in Greece 

and other countries in the euro area periphery and again in the late fall when troubles centered in 

Ireland. Elevated financial stress in the periphery of the euro area has carried over into early 

2011, this time centering on Portugal. 

Major advanced economy ten-year sovereign yields were below pre-crisis levels throughout 

2010, with yields declining through much of the first half of 2010, rising in the fall, but still 

ending the year below where yields started the year. Sovereign yields on ten-year maturities in 

the European periphery economies widened to near 10 percent in some countries and over 10 

percent in Greece; while spreads over Treasuries in emerging market economies declined 

throughout the year to at or below pre-crisis levels. Equity markets across all regions gained in 

2010. 

 

2

 The IMF includes Korea and Taiwan in the advanced economy category. In the charts above we group these two 

economies with other emerging markets. 

7
Through the first quarter of 2011, ten-year sovereign yields for most European economies 

increased marginally, though sovereign debt concerns raised yields by 300 basis points in Greece 

and Portugal. Non-European advanced economy and emerging market yields moved by less than 

one percent over the first quarter of 2011, ending in March close to year-beginning values. 

Equity markets in the advanced economies maintained moderate growth through the first quarter, 

but almost all major advanced countries’ equities contracted from February into March. 

Emerging market equities were mixed for the beginning of 2011, though most finished the first 

quarter higher than year beginning values. The Asian emerging markets and oil-producing 

countries showed the strongest growth into March, though China’s equity market contracted by 

0.5 percent. 

2.8

3.9

10.3

3.5

7.5

6.1

1.7

2.8

1.4

9.6

2.5

4.5 4.5

1.6

U.S. Japan China Germany Brazil Korea Euro‐Area

Real Growth Rates, 2010 ‐ 2011 The IMF projects global growth will 

moderate to 4.4 percent in 2011 with the 

advanced economies growing by 2.4 

percent and the emerging and developing 

economies growing by 6.5 percent. 

Following the earthquake and tsunami in 

March 2011, the IMF revised downwards 

its projection for Japan’s economic 

growth in 2011, though it expressed 

confidence in Japan’s recovery and 

revised upwards its 2012 projected 

growth to 2.1 percent. 

2010 2011 est

Source:  IMF

Inflation was contained throughout 2010 in most advanced economies, averaging 1.5 percent 

according to the IMF, but picked up to 6.2 percent in emerging markets. In the former group, 

economic slack restrained upward price pressures while, in the latter, stronger economic activity 

and rising food prices boosted inflation by 1 percentage point over 2009. Commodity prices 

rose throughout 2010, most sharply in the second half of the year. The Commodity Research 

Bureau (CRB) index of commodity prices rose 25 percent in 2010, and a further 11.4 percent in 

the first quarter of 2011. The CRB food sub index rose 22 percent in 2010, and is up 16.8 

percent in the first quarter of 2011. Crude oil prices (based on the WTI price) rose 29 percent in 

2010 and increased 15.6 percent in the first quarter of 2011. Commodity prices have been driven 

upward in part by the global recovery in demand but also by supply constraints, most particularly 

in the case of food, where bad weather reduced the stocks of key grains – including rice and 

wheat. 

As the global recovery has broadened and inflation has picked up, attention has increasingly 

shifted to the withdrawal of the extraordinary stimulus provided in 2009 and 2010. At the G-20 

Leaders Summit in Toronto in June 2010, Leaders of the advanced economies (except Japan) 

committed to halving their budget deficits by 2013 and to stabilizing or reducing their debt-toGDP ratios by 2016. Many G-20 countries are planning to gradually reduce their budget deficits 

beginning in 2011. The United States remains committed to the Toronto objectives. 

Monetary policy was on hold or eased somewhat among the major advanced economies in 2010. 

Australia and Canada were exceptions among the advanced economies, raising policy rates in 

2010 by 100 and 75 basis points, respectively. In April 2011, the European Central Bank raised 

its key interest rate by 25 basis points. In emerging markets, however, where inflation is higher 

8
and has been moving up in some economies, a number of economies, including Brazil, China, 

India, Korea, and Taiwan, have taken steps to tighten monetary conditions. 

As the global economy has recovered, and investor risk appetites have returned, global capital 

flows have picked up. The fundamental driver of increased capital flows to emerging markets is 

the strengthened performance of these economies, especially relative to advanced economies, 

and the ensuing higher yields on emerging market investments, particularly in the context of 

continued easy monetary policies in the advanced economies. Though data are only partial and 

suffer lags, the evidence suggests that capital inflows to emerging markets had returned to precrisis levels in the second half of 2009 and continued at that pace through mid-2010. Beginning 

in late September and running through the first week of November, capital flows to emerging 

markets increased, most prominently equity flows, before tapering off. In December, flows were 

back to levels prevailing for most of the past 18 months and the several years prior to the crisis. 

In response, a number of countries have either implemented or are contemplating putting in place 

capital controls or prudential measures. 

The combination of accelerating inflation and increased capital inflows has made some emerging 

markets reluctant to allow traditional monetary and exchange rate responses to operate. Some of 

these economies have opted for a combination of capital controls and prudential measures to 

mitigate the degree of tightening via interest rate or exchange rate channels. Restrictions on 

capital inflows and intervention to maintain rigid exchange rates in some countries, especially in 

Asia, have diverted capital flows to other emerging markets with open capital accounts and 

more flexible exchange rate policies, forcing the latter to bear the brunt of adjustment and 

leading in some cases to overvalued exchange rates. 

Global current account 

imbalances widened in 2010 

from their crisis-related lows. 

The combined external 

imbalances of the G-20, 

which represent 85 percent of 

global output remained well 

above the long-term average 

in 2010, and are projected by 

the IMF to remain above 

average through 2016 absent 

policy adjustments. 

At the initiative of the United 

States, Leaders of the G-20 agreed in November 2010 to intensify their efforts to get at the root 

causes, impediments, and needed policies to accelerate adjustment of external imbalances. That 

work is ongoing, with the goal of a G-20 policy action plan by the fall of 2011. More broadly, 

the G-20 is focused on putting in place the building blocks of a more effective and efficient 

international monetary system, of which a central component is a consensus that all 

systemically-important G-20 economies must have fully flexible, market-determined exchange 

rates.

0

1

2

3

4

5

6

20002001200220032004200520062007200820092010201120122013201420152016

G‐20 External Imbalances as a share of G‐20 GDP

China Germany

Japan United States

other G‐20 G‐20 average 1985:2005

Source:  IMF World Economic Outlook, April 2011

9
U.S. International Accounts 

The U.S. current account deficit in 

2009 was the smallest since 1999 in 

dollar terms and the smallest as a 

share of GDP since 1998. In 2010 the 

U.S. current account deficit widened 

by $91.8 billion to 3.2 percent of 

GDP, a 0.5 percentage point increase 

over 2009. This included a 0.5 

percentage point widening in the nonoil goods and services deficit and a 0

percentage point increase in the oil 

deficit. The net investment income 

surplus increased by $42.1 billion to partially offset the increase in the trade deficit. 

‐6

‐5

‐4

‐3

‐2

‐1

0

2007‐Q2

2007‐Q3

2007‐Q4

2008‐Q1

2008‐Q2

2008‐Q3

2008‐Q4

2009‐Q1

2009‐Q2

2009‐Q3

2009‐Q4

2010‐Q1

2010‐Q2

2010‐Q3

2010‐Q4

U.S. Current Account Balance as a Percent of GDP

.5 

U.S. Balance of Payments and Trade

($ billions, seasonally adjusted unless indicated) 2008 2009 2010 2010-Q1 2010-Q2 2010-Q3 2010-Q4

Current Account

 -- Balance on goods -834.7 -506.9 -647.1 -150.9 -169.1 -170.8 -156.2

 -- Balance on services 135.9 132.0 151.4 37.0 36.6 38.2 39.5

 -- Balance on income 1/ 152.0 121.4 163.0 40.1 42.9 41.4 38.6

 -- Net unilateral current transfers -122.0 -124.9 -137.5 -34.9 -33.2 -34.2 -35.2

Balance on current account -668.9 -378.4 -470.2 -108.7 -122.7 -125.5 -113.3

Balance on current account as % of GDP -4.7 -2.7 -3.2 -3.0 -3.4 -3.4 -3.1

Major Capital Flow Components (financial inflow +)

 Net bank flows 10.7 -590.1 -326.9 -108.0 -63.8 -89.3 -65.9

 Net direct investment flows -22.8 -134.0 -151.2 -51.2 -54.4 -9.2 -36.3

 Net sales of securities 917.3 290.2 638.2 149.7 114.7 249.7 124.1

 Net liabilities to unaffiliated foreigners by nonbank concerns 384.6 123.0 51.5 31.7 20.7 -14.9 14.0

Memo Items

 Statistical discrepancy 85.0 162.5 235.1 73.9 91.7 -11.4 80.9

 Change in foreign official assets in the United States 550.8 450.0 298.0 72.5 43.6 132.9 49.1

Trade in Goods: Balance -816.2 -503.6 -633.9 -148.0 -166.2 -167.2 -152.5

Total exports, of which: 1287.4 1056.0 1278.1 303.6 313.8 321.1 339.6

 -- Agricultural products 108.4 93.9 107.7 26.5 23.9 26.0 31.4

 -- Capital goods except autos 457.7 390.5 445.9 105.8 110.5 113.8 115.8

 -- Automotive products 121.4 81.7 111.9 27.1 28.3 27.9 28.5

 -- Consumer goods except autos and food 161.3 150.0 165.8 40.7 40.4 41.2 43.5

 -- Industrial supplies and materials 2/ 388.0 296.7 390.7 90.5 97.1 97.4 105.7

Total imports, of which: 2103.6 1559.6 1912.0 451.6 480.0 488.3 492.1

 -- Petroleum and products 779.5 462.5 601.3 85.3 84.6 81.7 84.5

 -- Capital goods except autos 453.7 369.3 449.3 101.9 112.2 116.4 118.8

 -- Automotive products 231.2 157.6 225.2 50.4 57.6 59.9 57.3

 -- Consumer goods except autos and food 481.6 428.4 483.3 113.9 120.7 125.0 123.7

1/ Including compensation of employees 2/ Including petroleum and petroleum products Source: BEA, Bureau of Census

The dollar value of U.S. exports of goods and services in 2010 increased 16.4 percent over 2009, 

while imports increased 19.8 percent. In real, price-adjusted terms, exports increased 11.7 

percent while imports increased 12.6 percent. 

On a quarterly basis, the current account deficit rose through the third quarter in 2010, reaching 

3.4 percent of GDP before declining to 3.1 percent of GDP in the fourth quarter. Exports of 

goods and services reached their pre-crisis level in the fourth quarter of 2011, but imports 

remained 10 percent below pre-crisis levels. 

10
The Dollar in Foreign Exchange Markets 

Over the course of the first four 

months of 2011, the dollar tended to 

trade in response to changes in 

relative interest rates, particularly 

among major economies, and shifts 

in global risk appetite. Based on the 

Federal Reserve’s nominal effective 

exchange rate index, the dollar 

depreciated by 7.1 percent against the 

other major currencies in the first 

four months of 2011 and 3.4 percent 

against the other important trading 

partners (OITP). The latter is a 

measure of the dollar’s value against 

emerging market currencies. Against the broad set of currencies (major and OITP combined), 

the dollar depreciated by 5.1 percent on a nominal effective basis in the first four months of 

2011. 

‐12 ‐10 ‐8 ‐6 ‐4 ‐2 0

Euro area

Switzerland

Mexico

United Kingdom

Brazil

Canada

Korea

Taiwan

China

Japan

PercentChange in the Value ofthe USDollar  

In the first fourmonths of 2011

On a real effective basis, 

the dollar depreciated by 

3.4 percent in the first 

four months of 2011. 

The euro appreciated by 

4.5 percent and the yen 

depreciated by 5.3 

percent. Taking a 

longer-term perspective, 

the euro is near its 

average value since the 

start of the BIS index in 

January 1994 whereas 

the dollar and the yen 

are below their longterm averages. 

60

70

80

90

100

110

120

130

Jan‐94Jan‐95Jan‐96Jan‐97Jan‐98Jan‐99Jan‐00Jan‐01Jan‐02Jan‐03Jan‐04Jan‐05Jan‐06Jan‐07Jan‐08Jan‐09Jan‐10Jan‐11

BIS Real Effective Exchange Rates

January 1994 to April 2011

With the exception of short-lived periods of heightened volatility surrounding an escalation of 

tension in the Middle East and the catastrophic earthquake and tsunami in Japan, a general 

moderation in asset and currency market volatility reduced safe haven demand for dollars 

through April 2011. The dollar depreciated against the currencies of all the economies discussed 

in this report during the first four months of 2011, with the exception of the Japanese yen. 

The dollar depreciated by 10.8 percent against the euro in the first four months of 2011 as 

investors increased their expectations that the ECB would raise policy rates (which it did in early 

April) and euro-area peripheral strains were believed to be increasingly contained. 

euro yen dollar

index 1/94=100

11
In the first two months of 2011 the dollar appreciated by 0.7 percent against the yen. However, 

in the aftermath of the March 11 Japanese earthquake and tsunami the yen displayed heightened 

volatility, appreciating sharply as speculative investors anticipated substantial repatriation flows 

into Japan to cover the costs of the earthquake. 

On March 18, authorities of the G-7 countries, including the United States, the United Kingdom, 

Canada, and the European Central Bank, joined Japan in a coordinated intervention in foreign 

exchange markets. At Japan’s request, G-7 nations entered the market in an effort to counter 

excess volatility and disorderly movements in the yen exchange rate. The G-7 has long stated 

that excess volatility and disorderly movements in exchange rates “have adverse implications for 

economic and financial stability.” The dollar appreciated by 7.9 percent against the yen from 

March 17 through April 6, but declined through the remainder of April. 

Analyses of Individual Economies 

Asia 

China

After a period of roughly two years in which the Chinese renminbi (RMB) was pegged to the 

U.S. dollar, Chinese authorities decided in June 2010 to allow the exchange rate to appreciate in 

response to market forces. Since the June announcement, the RMB has appreciated by a total of 

5.1 percent against the dollar through the end of April 2011, or at a rate of approximately 6 

percent per year in nominal terms. Because inflation in China is higher than it is in the United 

States, the RMB has been appreciating more rapidly against the dollar on a real, inflationadjusted basis, at a rate of around 9 percent per year. A more rapid pace of nominal appreciation 

would enable China to achieve the needed adjustment in the real value of its currency, while 

simultaneously reducing inflationary pressures in its economy. 

The Chinese economy continued to grow rapidly in 2010 and so far in 2011. In the first quarter 

of 2011, China’s economy expanded by 9.7 percent in real terms year-on-year, down slightly 

from 9.8 percent growth in the fourth quarter of 2010. As part of the first quarter data release, 

China’s National Bureau of Statistics reported, for the first time, sequential seasonally adjusted 

data, which showed a 2.1 percent quarter-on-quarter rise in real GDP, equal to an annualized 

growth rate of 8.7 percent. In 2010, China’s economy expanded by 10.3 percent in real terms, 

with the contribution from investment accounting for over half of the growth. The IMF forecasts 

real GDP growth of 9.6 percent for 2011 as a whole. 

Controlling inflation has become a top priority for Chinese authorities in 2011. Throughout 

2010 and the first quarter of 2011, China has shifted to less stimulative monetary policies. The 

People’s Bank of China (PBOC) cut the rate of broad money (M2) growth to 16.6 percent in the 

first quarter of 2011 (from 19.7 percent in 2010) and increased the amount of reserves that large 

commercial banks are required to hold at the central bank, from 15.5 percent of total deposits at 

the beginning of 2010 to 20.5 percent as of mid-April 2011. The PBOC also raised China’s 

benchmark 1-year lending rate four times since the beginning of October 2010, with a total 

increase of 100 basis points from 5.31 percent to 6.31 percent. 

12
Despite these policy measures, the inflation rate has continued to climb. China’s consumer 

prices rose 5.4 percent year-over-year in March 2011, up from 2.4 percent in March 2010. 

Although the rise in inflation primarily has been driven by higher food costs, non-food consumer 

price inflation reached 2.7 percent year-over-year in March 2011, its highest level in more than 

ten years. Most likely reflecting in part the continued rise in housing and food prices, Chinese 

household surveys continue to show relatively low levels of satisfaction with current inflation, 

and relatively high expectations of future inflation. Chinese authorities set a 4 percent target for 

inflation in 2011. 

China’s exchange rate regime impairs its ability to contain inflation. Rather than following the 

accepted practice of increasing domestic interest rates to contain inflation, the PBOC has limited 

increases in domestic interest rates in order to avoid additional capital inflows. The PBOC’s 

approach will in turn require it to further increase foreign exchange purchases to maintain a 

stable renminbi. 

In addition, strictly regulated low domestic interest rates mean that Chinese households earn very 

little on their savings, and a declining amount in real terms as domestic inflation in China 

accelerates, constraining the growth of household income and consumption relative to national 

income.3

 The exchange rate itself can also serve as a tool to counter inflation, as appreciation of 

the RMB reduces the local currency price of imports. 

There has been increasing recognition of the role of exchange rate appreciation in addressing 

inflation in China. On April 19, People’s Bank of China Deputy Governor Hu Xiaolian stated 

that China should “increase exchange rate flexibility to ease imported inflation pressures," and in 

comments to China’s State Council in April, Premier Wen noted that “strengthening the 

flexibility” of the exchange rate can serve as one of the tools available to control inflation. 

During the recent Strategic and Economic Dialogue (S&ED), China stressed that it “will 

continue to promote RMB exchange rate flexibility.” 

China’s current account surplus fell from 9.1 percent of GDP in 2008, to 5.2 percent in 2009. 

The current account surplus was $305.4 billion in 2010, approximately the same share of GDP as 

in 2009.4

 Preliminary data for the first quarter of 2011 indicated a current account surplus of 

$29.8 billion, equal to 2 percent of first quarter GDP. The IMF currently forecasts China’s 2011 

current account will reach 5.7 percent of GDP. 

Although China experienced a sharp slowdown in external demand during the crisis, the rebound 

has been rapid. China’s international trade has recovered to well above its pre-crisis level, and 

China’s exports have continued to gain global market share through the last three years. Goods 

exports on a balance of payments basis rose 31.4 percent in 2010 and are 10 percent above their 

2008 level. Imports rose 39.1 percent in 2010 and are 24 percent above their 2008 level. The 

2010 goods and services trade surplus was 3.9 percent of GDP, compared to 4.4 percent of GDP 

in 2009, and 7.7 percent in 2008. In the first quarter of 2011, preliminary balance of payments 

 

3 Since 2004, average one-year deposit rates have not been sufficient to compensate depositors for consumer price 

inflation; the real deposit interest rate has averaged a negative 0.1 percent. In the six year period before 2004, when 

capital inflows and sterilization were not serious concerns for policy makers, the average real deposit rate for 

Chinese consumers was 2.5 percent. 

4

 Chinese authorities recently revised the methodology used to account for retained earnings in the income and FDI 

balances of its balance of payments data, and have issued revised data for the 2005-2010 period. 

13
data indicate that China experienced a goods trade surplus of $20.8 billion, as imports grew 32.8 

percent while exports grew 26.7 percent compared to the first quarter of 2010. China’s trade 

surplus is usually relatively low in the first quarter of the year due to seasonal factors, but 

rebounds later in the year. China’s trade balance has also been lowered recently by the 

deterioration in China’s terms of trade tied to the rise in commodity prices. In April, however, 

based on China’s Customs data, China recorded a trade surplus of $11.4 billion, as export growth 

significantly outpaced import growth. 

The Chinese leadership recognizes that China is now too large relative to the world economy for 

it to continue to rely on foreign demand to grow. At the S&ED, China stated, “In order to 

promote a more balanced trade relationship, China will continue to take steps to expand domestic 

consumption and imports in accordance with the 12th Five-Year Plan.” China’s Twelfth FiveYear Plan, adopted on March 14, incorporated a number of specific targets to achieve these goals 

– targets which China reaffirmed bilaterally through the S&ED. At the S&ED, China committed 

to take steps to increase domestic consumption, including raising household incomes at a pace 

faster than GDP growth, steadily increasing the minimum wage, and ensuring that workers’ pay 

keeps up with increases in productivity. China also pledged to raise the share of the services 

sector in China’s economy by four percentage points over the next five years (an important 

element in expanding domestic consumption), and committed to further open the service sector 

to U.S. and other foreign participation. Finally, China committed to promote more market-based 

interest rates, which should over time increase household income and consumption by increasing 

the inflation adjusted return on household savings, which still largely remain in bank deposits. 

China’s Five-Year Plan also aims to substantially expand the social safety net, continue price 

reform in the resource sector, and increase payment of dividends by state-owned enterprises, all 

of which have the potential to contribute to economic rebalancing. 

These policy commitments are welcome, but it is important that China take more effective policy 

actions to bring about a durable reduction in its external imbalances, as it aims to do in the 

Twelfth Five-Year Plan. Otherwise, China’s current account surplus will likely increase again, 

both in absolute terms and as a share of China’s GDP. Exchange rate reform is an important 

element in this process to ensure that Chinese production shifts in a durable way to reflect an 

economy more dependent on domestic demand for growth. 

 

As market pressure for further exchange rate appreciation increased in 2010, the PBOC stepped 

up its foreign exchange intervention, purchasing dollars with RMB and adding to foreign 

exchange reserves. In 2010, China’s foreign exchange reserves rose by $448 billion, and they 

have increased by a further $197 billion in the first quarter of 2011. In total, the PBOC held $3.0 

trillion worth of foreign reserves at the end of the first quarter of 2011, equivalent to 52 percent 

of China’s 2010 GDP, over 27 months of imports, and more than $2,000 for every Chinese 

citizen.5

 

In order to promote greater international use of the renminbi, China has taken steps to gradually 

increase convertibility of the renminbi, allowed for the use of renminbi in trade settlement, and 

 

5

 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 $3.6 trillion in foreign currency assets. 

China’s foreign exchange reserves held in the state sector are roughly three times as high as the reserves held by 

Japan, the economy with the second largest holdings. 

14
liberalized some capital account transactions. Although still limited in scope and tightly 

controlled by Chinese authorities, these reforms have spurred rapid growth (albeit from a very 

small base) of an off-shore renminbi market. Off-shore renminbi deposits, mostly concentrated 

in Hong Kong, have increased from RMB 64 billion ($9.9 billion) in January 2010 to RMB 451 

billion ($69.5 billion) in March 2011. In the first quarter of 2011, Chinese authorities reported 

that approximately 7 percent of China’s trade was settled in renminbi, up from 0.4 percent in the 

first quarter of 2010. To date, the use of RMB for payment of Chinese imports has far exceeded 

the amount of RMB received as payment for Chinese exports. As a result, there is relatively less 

drain on the on-shore stock of foreign exchange, and a correspondingly larger increase in net 

foreign exchange inflows, than otherwise would have occurred. 

China’s real effective exchange rate — a measure of its overall cost-competitiveness relative to 

its trading partners — has appreciated only modestly over the past decade. China’s large 

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

and increased investment in its productive capacity which accompanied its accession to the WTO 

all suggest that the RMB should have appreciated more significantly on a real effective basis 

over this period. A renminbi which is below its equilibrium value decreases the purchasing 

power of China’s consumers. Undervaluation increases the price tag on items such as imported 

food or gasoline, new homes built with imported materials, or a foreign automobile. It also 

encourages Chinese firms to produce for export markets rather than domestic consumers, placing 

an additional damper on the growth of domestic demand. 

These factors highlight why exchange rate flexibility must play an important role in rebalancing 

China’s economy towards domestic demand-led growth. Greater RMB flexibility would also 

reduce incentives for intervention by other economies trying to maintain trade competitiveness 

vis-à-vis China, further promoting global rebalancing and removing distortions and negative 

externalities from the international monetary system. 

China’s continued rapid pace of foreign reserve accumulation; the broadly unchanged level of 

China’s real effective exchange rate, especially given rapid productivity growth in the traded 

goods sector; and the projected widening of current account surpluses, all indicate that the real 

exchange rate of the renminbi remains substantially undervalued. China’s consistent, large 

reserve accumulation prolongs a substantial undervaluation and hampers progress toward global 

rebalancing. It is in China’s interest to allow the nominal exchange rate to appreciate more 

rapidly, both against the dollar and against the currencies of its other major trading partners. If it 

does not, China will face the risk of more rapid inflation, excessively rapid expansion of 

domestic credit, and upward pressure on property and equity prices, all of which could threaten 

future economic growth. By trying to limit the pace of appreciation, China is not allowing the 

exchange rate to serve as a tool to counter inflation. The policy complicates the adjustment 

needed for broader financial sector reform. It works against China’s stated goal of strengthening 

domestic demand. And it places an undue burden of adjustment on other emerging market 

economies that maintain more flexible exchange rate systems and that have already seen 

substantial exchange rate appreciation. 

Japan

Japan maintains a floating exchange rate regime, but its authorities have intervened in the past, 

both individually and jointly with the G-7 to counter disorderly conditions in the market. 

15
Japanese authorities recently have intervened twice in foreign exchange markets, once alone on 

September 15, 2010, and jointly with the G-7 on March 18, 2011. 

On March 11, 2011, the Tohoku region northeast of Tokyo was struck by a 9.0-magnitude 

earthquake, followed by a massive tsunami. As of early April, the death count was over 14,000, 

with an additional 13,500 persons still missing. The tsunami also triggered the most serious 

nuclear incident since the 1986 Chernobyl disaster as power needed to operate the cooling 

system at a major reactor complex at Fukushima was disrupted. Damage to public infrastructure 

and private capital stock, as estimated by Japanese authorities, totals ¥16-25 trillion (roughly 

$200-300 billion, or 3-5 percent of Japanese GDP). Over the course of three trading days 

following the March 11 earthquake, the yen appreciated by 7.9 percent against the dollar, 

reaching a record ¥/$76.25 on March 16. The appreciation resulted in part from market views 

that Japanese banks and insurers might repatriate overseas investments. The benchmark Nikkei 

225 and Topix stock indices both dropped 11 percent over the same period. 

In response to these disorderly conditions, and at the request of the Japanese authorities, the 

authorities of the United States, the United Kingdom, Canada, and the European Central Bank 

joined with Japan on March 18, 2011, in concerted intervention in exchange markets. The 

coordinated intervention by the G-7 was the first in over a decade. 

On March 18, the day of the G-7 announcement to intervene, the yen depreciated by 3.1 percent 

to ¥/$81.70, and the Nikkei and Topix indices rose by 2.7 percent and 2.4 percent respectively. 

The yen continued to weaken to ¥/$85.25 on April 7, before beginning to strengthen again. By 

late April the yen was trading around ¥/$81-82, similar to pre-earthquake levels. The yen rose 

0.1 percent against the dollar in the first four months of 2011 but depreciated by 3.7 percent on a 

nominal trade-weighted basis, and 5.3 percent on a real trade-weighted basis. In contrast the yen 

rose by 11.5 percent against the dollar in 2010 and appreciated by 3.9 percent on a real tradeweighted basis. In March, Japan’s foreign exchange reserves increased to $1.04 trillion from 

$1.03 trillion in February as a result of valuation changes on existing reserve holdings, interest 

earnings, and foreign exchange intervention. 

Prior to the earthquake, Japan’s economy was recovering at a moderate pace from the global 

financial crisis. The economy grew 3.9 percent in 2010, with net exports driving growth in the 

first two quarters. In the fourth quarter, however, real GDP declined 1.3 percent on a seasonally 

adjusted annualized basis, as exports slowed, government incentives for consumers expired, and 

domestic demand remained weak. In the first quarter of 2011, as a result of both supply 

disruption and reductions in demand after the March 11 earthquake, Japanese GDP fell sharply, 

at a seasonally-adjusted annualized rate of 3.7 percent. The impact of the disaster is likely to 

continue into the second quarter. Once reconstruction begins, however, economic growth is 

likely to receive a boost in the second half of 2011 and in 2012. The timing of the impetus to 

growth from reconstruction will depend in part on the resolution of the situation at the 

Fukushima Dai-ichi nuclear power plant, as well as the restoration of the power grid. The private 

sector consensus forecast, as of April, is 0.3 percent for 2011 and 2.7 percent for 2012. 

Over a longer time horizon, Japan will need to tackle its large fiscal deficit and public debt. 

Reforms to strengthen domestic demand and foster competition and productivity growth will be 

critical for Japan’s long-term growth and fiscal health, and key to meeting Japan’s commitment 

to contribute to the G-20 objective of strong, sustainable, and balanced global growth. The 

16
Japanese government announced a ¥4 trillion ($49 billion) supplemental budget on April 25, and 

is planning two more supplemental budgets this year to assist in reconstruction. Japan’s general 

government deficit widened from 3.2 percent of GDP in FY 2008 (April-March) 9.4 percent of 

GDP in FY 2009. The IMF projects the government’s gross debt to reach 229 percent of GDP in 

2011. 

Japan’s current account surplus increased from $144 billion (2.8 percent of GDP) in 2009 to 

$195 billion (3.6 percent of GDP) in 2010, as external demand and the merchandise trade surplus 

recovered. Exports slowed significantly in the first quarter of 2011, however, particularly in 

January, when the trade balance fell into the first monthly deficit since early 2009. As a result, 

Japan’s merchandise trade surplus declined sharply to $4.5 billion in the first quarter of 2011 

from $20.5 billion in the fourth quarter of 2010. Japan’s bilateral trade surplus with the United 

States increased to $59.8 billion in 2010 from the 18-year-low of $44.7 billion in 2009, but 

remains well below its pre-crisis average of $77.5 billion from 2000-07. 

South Korea

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

with the stated objective of smoothing won volatility. During the most severe period of the 

global financial crisis, Korea intervened heavily to support the won. Since early 2009, Korea has 

intervened in the opposite direction, selling won and buying foreign currency to rebuild foreign 

exchange reserves and slow won appreciation. In the first four months of 2011, the won 

appreciated by 4.7 percent against the U.S. dollar and 2.9 percent on a nominal trade-weighted 

basis through April. On a real effective basis the won appreciated by 3.5 percent during the first 

four months of 2011. The won remains 20 percent below its 2007 peak against the dollar, 

however, and is 22 percent weaker than its pre-crisis high in real effective terms, despite the 

strong recovery of Korea’s domestic economy, exports, and foreign reserves. According to 

estimates from the September 2010 IMF Article IV consultation with Korea, the won was 

undervalued relative to its equilibrium level on a real effective basis (estimates range from 5 to 

20 percent). 

South Korea’s economy continues to recover strongly from its sharp downturn in 2008, growing 

6.2 percent in 2010, a significant rebound from 0.2 percent growth in 2009. Real GDP grew 4.2 

percent year-over-year in the first quarter of 2011, primarily driven by net exports. The IMF 

expects economic growth of 4.5 percent and 4.2 percent in 2011 and 2012, respectively, similar 

to pre-crisis growth rates. Inflation now has become one of the main challenges for the Korean 

economy. Headline consumer price growth was 4.1 percent year-over-year in April, above the 

Bank of Korea’s medium-term target range of 2 to 4 percent. Import prices have been rising 

rapidly over the past several months, up 17 percent in the first quarter of 2011 over the first 

quarter of 2010, driven by oil and commodity prices. The Bank of Korea has raised its policy 

interest rate twice in 2011, by 25 basis points each in January and March. The rate now stands at 

3 percent, which is below its pre-crisis level of around 5 percent in 2007 through mid-2008, 

when inflation exceeded 5 percent year-over-year. 

Korea’s merchandise trade surplus was $8 billion in the first quarter of 2011, the largest first 

quarter surplus for Korea since 1998, as exports increased by 30 percent year-over-year. The 

private sector consensus forecast for Korea’s 2011 trade surplus is $33.7 billion (about 3 percent 

of GDP). After falling into deficit in 2008, Korea’s current account has averaged a surplus of 3.3 

17
percent of GDP over the past nine quarters, and totaled $28.2 billion (2.7 percent of GDP) in 

2010. Korea’s trade surplus with the United States was $10.0 billion in 2010, down from $10.6 

billion in 2009. 

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

it borrowed externally. Since 2008, the Korean authorities have taken a number of measures to 

reduce short term external debt and foreign exchange exposure of the financial system. In 

November 2009, the government announced limits on domestic banks and foreign bank 

branches’ foreign currency forward positions, and required domestic banks to hold a part of their 

foreign assets in “safe” investments rated A or above, which took effect in January 2010. In 

June 2010, the government introduced caps on foreign exchange derivatives contracts for both 

domestic banks and branches of foreign banks located in Korea, effective October 2010. Last 

November, the government proposed reinstating a withholding tax on foreign investors’ gains 

from Korean government bonds, which passed parliament and came into effect in January 2011. 

Most recently, last December the government proposed a tax on banks’ foreign borrowing, with 

higher rates on short-term maturity debt, which will take effect this August. The authorities have 

also conducted audits of banks’ trading of foreign exchange derivatives in recent months. In part 

due to the government’s measures, Korea’s short-term external debt has declined from $189 

billion in the third quarter of 2008 to $135 billion at the end of 2010. 

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

over $90 billion since end-2008 to a record $299 billion in March. This is $30 billion above 

their pre-crisis peak and equivalent to 7.8 months of imports and over twice the amount of shortterm external debt. The Bank of Korea continues to be active in the forward market, and Korea’s 

net long foreign currency/short domestic currency forward position has largely been increasing 

since early 2009. It stood at $52.4 billion in March 2011, compared to -$11.1 billion in February 

2009. Given the strong domestic recovery, the rebuilding of foreign exchange reserves, rising 

inflationary pressure, and the rebound in the current account, Korea should adopt a greater 

degree of exchange rate flexibility and less intervention. 

Taiwan 

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

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

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

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

an orderly market.” The Taiwan dollar appreciated by 1.7 percent against the U.S. dollar in the 

first four months of 2011, following an appreciation of 8.8 percent during 2010. According to 

BIS statistics, the real effective exchange rate of the Taiwan dollar depreciated by 0.5 percent in 

the first four months of 2011, after appreciating 4.3 percent in 2010

 

Taiwan’s real GDP increased by 10.8 percent last year, as a result of both rising exports and 

strengthening domestic demand. First quarter real growth in 2011 was 6.2 percent year-on-year 

and 13.4 percent on a seasonally-adjusted annualized rate, on strong exports and private 

consumption. The authorities expect real growth of 5.0 percent in 2011, while the IMF projects 

growth at 5.4 percent. Taiwan’s inflation rate remains one of the lowest in Asia, with consumer 

prices increasing by only 1.4 percent year-on-year in March. Government price and 

administrative controls have partially offset rising imported commodity and fuel prices. The 

18
central bank, citing a strong economy and rising inflation, particularly in the housing sector, 

raised its discount rate by 12.5 basis points to 1.75 percent on March 31, following a series of 

three 12.5 basis point hikes in 2010. To deter speculation in the property market, on April 15, 

2011, the legislature approved a new luxury tax of 10-15 percent on property sold within two 

years of purchase. 

Taiwan’s current account surplus narrowed moderately in 2010 on a smaller trade surplus as 

imports rose faster than exports. The current account surplus contracted to $40.6 billion or 9.4 

percent of GDP, compared with 11.4 percent in 2009. The trade balance accounted for $26.9 

billion of the surplus in 2010, down from $42.9 billion in 2009. The trade surplus narrowed in 

the first quarter of 2011, with exports rising 19.5 percent and imports increasing 21.8 percent on 

a year-over-year basis. The income surplus declined slightly to $13.6 billion in 2010. The 

financial account recorded a net outflow of $0.6 billion in 2010 compared with the large surplus 

of $13.6 billion in 2009, as foreign portfolio inflows and increases in foreign lending by the 

banking sector offset overseas investment in debt securities by insurance companies and in 

mutual funds by residents. Taiwan’s foreign exchange reserves increased by $11 billion to $393 

billion during the first four months of 2011, due to valuation gains and net purchases of foreign 

exchange. Taiwan’s foreign exchange reserves amount to 88 percent of GDP, 18.5 months of 

imports, and about 4.5 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 

fluctuate significantly against the dollar, in part because of changing perceptions about relative 

risks related to sovereign debt. The Irish sovereign debt crisis contributed to a 4.3 percent fall in 

the euro against the dollar in the two months to end-November 2010. Driven by interest rate 

differentials, the euro rallied against the dollar in early 2011 despite worsening debt problems in 

Portugal; rising 9.7 percent during the first four months of the year. On a real effective basis, the 

euro appreciated by 4.5 percent in the first four months of 2011. On March 18, the ECB 

participated in the joint G-7 intervention to prevent excess volatility in the yen. 

The euro area returned to growth in 2010, with real GDP expanding by 1.8 percent, and the 

recovery is continuing into 2011. The economic rebound is broad-based, with private 

consumption, government consumption, and net exports all contributing to GDP growth, 

although fixed investment continued to decline slightly last year. To a large extent, however, the 

euro area’s recovery masks a wide divergence across countries. The German economy grew 3.6 

percent in 2010, but growth was much more modest in France (1.5 percent) and Italy (1.3 

percent). In Spain and some smaller euro area countries, real GDP continued to decline. 

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

account deficit grew marginally in 2010 to 0.4 percent of GDP from 0.3 percent in 2009. 

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

euro area countries. The Netherlands and Germany each had substantial current account 

surpluses in 2010, at 7.7 and 5.6 percent of GDP, respectively, and growth there has been driven 

by net exports. Since their economic recoveries began in 2009, net exports have accounted for 

over 60 percent of economic growth in Germany and the vast majority of growth in the 

19
Netherlands. Meanwhile, 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 reduce imbalances in the euro area. 

The debt crises in the European periphery countries shifted the focus to deficit reduction, even in 

those countries with more moderate debt levels. Most of the major euro area economies have 

committed to reducing their general government budget deficits to under 3 percent of GDP by 

2013; although the German government recently announced that it would meet this deficit target 

this year. 

The debt crisis affecting several euro area countries prompted the European Central Bank (ECB) 

to revise its plans to withdraw its exceptional liquidity measures, but it is now again cautiously 

pursuing an exit strategy. The ECB continues to provide unlimited, fixed-rate liquidity, but 

raised its refinancing rate from 1 percent to 1.25 percent in April. There has been a steady 

decline in the volume of ECB liquidity demanded by euro area banks, as banks have regained 

access to the interbank market. Banks in the euro area “periphery,” however, remain heavily 

dependent on ECB refinancing, which will complicate the central bank’s exit strategy. 

Meanwhile, the ECB has all but halted its sovereign bond purchase program, which it had 

instituted in May 2010 to reduce funding stresses in sovereign debt markets for some countries in 

the euro area periphery. The ECB has purchased less than €80 billion in securities under this 

program as of April 22, 2011, and most of these purchases were made in the program’s first 

months (including €26 billion in May). 

Switzerland

The Swiss franc is a freely floating currency and the Swiss National Bank (SNB) sets monetary 

policy in order to keep inflation stable at around 2 percent. In 2010, the SNB sought to stem 

“excessive” appreciation against the euro to address deflation concerns, since CPI inflation 

remained well below its 2 percent target. The Swiss franc experienced appreciation pressure in 

2010 due to the rising Swiss current account surplus, concerns about economic and financial 

developments in the euro area, and “safe haven” capital inflows attracted by Switzerland’s low 

net government debt and fiscal surplus. 

The Swiss economy grew by 2.6 percent in 2010 owing to strong exports, rising domestic 

demand, and robust fixed investment. After falling in the first quarter of 2010, domestic demand 

strengthened in the remainder of the year, increasing 0.6 percent overall in 2010. Public 

consumption fell by 1.6 percent in 2010 as the recovery strengthened. 

In March 2009, the SNB initiated a policy to intervene in the foreign exchange market to 

“prevent any appreciation of the Swiss franc against the euro.” These interventions were 

unsterilized and, as the threat of deflation diminished and upward pressure on the Swiss franc 

continued, the SNB subsequently amended its policy. In March 2010, the SNB shifted its stance 

to prevent “excessive” appreciation and, in June 2010, appeared to end its foreign exchange 

intervention policy altogether, noting that it would resume intervention if further currency 

appreciation threatened deflation. Consumer prices rose by 0.7 percent in 2010, and are up 0.9 

percent year-over-year as of March 2011. 

20
Switzerland’s foreign exchange intervention resulted in a substantial increase in foreign 

exchange reserves through June 2010, when its foreign exchange reserves reached $208.0 

billion, substantially higher than the $49.1 billion in March 2009 when the intervention policy 

began. International reserves showed little increase in the second half of 2010, however, 

increasing by $9.4 billion to $217.4 billion, and this change was due to valuation changes rather 

than intervention. At the end of February 2011, Swiss foreign exchange reserves were $223.9 

billion. 

The Swiss franc depreciated by 4.1 percent against the dollar in the first half of 2010, but 

appreciated by 13.3 percent in the second half of 2010 and by an additional 7.4 percent in the 

first four months of 2011. On a real effective basis, the Swiss franc rose by 9.4 percent in 2010 

and has risen by 0.2 percent through the first four months of 2011. Despite this real exchange 

rate appreciation, Switzerland’s current account surplus rose to 14.6 percent of GDP in 2010 

from 11.5 percent of GDP in 2009, driven by a 39 percent increase in net investment income. 

United Kingdom

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

depreciated by 3.6 percent against the dollar during 2010, falling through much of the first half 

of the year, but rising 4.2 percent in the second half of 2010. The pound has continued to 

appreciate into early 2011, rising 6.6 percent against the dollar through the end of April as 

above-target inflation increased prospects of a widening interest rate differential. On a real 

effective basis, the pound depreciated by 0.6 percent in the second half of 2010 and by an 

additional 1.3 percent in the first four months of 2011, reflecting the pound’s nominal 

depreciation against other currencies excluding the dollar, notably the euro. The Bank of 

England (BOE) participated in the joint G-7 intervention on March 18 to prevent excess 

volatility in the yen. 

The UK economy rebounded in 2010, expanding 1.3 percent. Modest growth resumed in the 

fourth quarter of 2009 and sustained positive momentum through the first three quarters of 2010, 

but contracted 1.9 percent on an annualized basis in the fourth quarter due in part to the 

temporary effects of bad weather. Real GDP rebounded in the first quarter of 2011, growing by 

2.0 percent. 

Economic expansion in 2010 was supported by robust manufacturing gains and inventory 

restocking. The UK’s current account deficit widened to 2.5 percent of GDP in 2010 as a result 

of a rising trade deficit. 

Stimulus measures, in conjunction with the economic downturn, resulted in a rise in the UK’s 

fiscal deficit from 2.3 percent of GDP in 2007 to 11.1 percent of GDP in 2009. Consequently, 

public gross debt increased from 43.6 percent of GDP in 2007 to 71.1 percent of GDP in 2009. 

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

accelerated reduction in the fiscal deficit, led by expenditure reductions. This austerity package, 

announced by the government in June, is expected to reduce the deficit to 2.5 percent of GDP by 

2014-2015 and to put the gross debt-to-GDP ratio on a declining path after peaking at 87 percent 

in 2012-2013. 

21
Monetary policy remains accommodative. The Bank of England (BOE) has maintained its 

historically low policy rate at 0.5 percent and the size of its quantitative easing program at £200 

billion through April 2011. Inflation has remained above the Bank of England’s 2 percent target 

for over a year and has been driven primarily by commodity and food prices, currency weakness, 

and the 2010 increase of the value-added tax. 

Western Hemisphere 

Brazil

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

performs regular and transparent interventions in the spot market for foreign exchange to smooth 

volatility. As a result of these operations, along with interest and valuation changes, total foreign 

exchange reserves increased by $74 billion over the past 12-months, reaching $312 billion at the 

end of April 2011. 

The real appreciated by 4.8 percent against the U.S. dollar in nominal terms in 2010, and an 

additional 5.2 percent in the first four months of 2011. In April 2011, the real surpassed its precrisis high against the dollar of R$1.56 per dollar. On a real effective exchange rate basis, the 

real appreciated by 7.8 percent in 2010 and an additional 5.0 percent in 2011 through April, 

based on data from the BIS. 

Preventing additional appreciation of the real from strong foreign capital inflows is a priority for 

the Brazilian government. In October 2010, the authorities raised the financial operations tax 

(IOF) on non-resident investment in fixed income assets to 6 percent from 2 percent previously. 

The authorities also have broadened the scope of the IOF tax, by extending the 6 percent IOF tax 

to foreign borrowing by residents with a maturity of less than two years (April 2011) and to 

inflows into margin accounts held by non-residents in local derivatives markets (October 2010). 

Since January 2011, Brazil’s central bank has intervened in foreign exchange derivatives markets 

through auctions of foreign exchange swaps and forwards. In January 2011, the central bank 

introduced unremunerated reserve requirements on the short U.S. dollar positions of financial 

institutions. 

Brazil experienced a strong economic recovery in 2010 following flat activity in 2009. The 

Brazilian economy expanded by 7.5 percent in 2010, concentrated in the first half amid 

convergence of strong consumer demand, residual fiscal stimulus, and inventory replenishment. 

Activity moderated in the second half of 2010, and the IMF projects real GDP growth to ease to 

4.5 percent in 2011. Consumption and investment (both public and private) continue to drive 

economic growth. 

Fiscal policy has remained expansionary in spite of the strong economic recovery. One-time tax 

credits were allowed to expire in 2010, but permanent increases to public payroll and 

discretionary expenditures as well as investment expenditures have maintained the fiscal 

impulse. In February 2011, the government announced intentions to reduce current year spending 

by R$50 billion (approximately 1.3 percent of GDP) and reduce annual financing to public 

financial institutions. Increased public lending by the national development bank (BNDES) and 

state-owned commercial banks played an important role in maintaining credit availability during 

22
the crisis, but public credit has maintained a consistent rate of expansion even as private credit 

has resumed. 

Robust private and public demand has increased inflationary pressure. Consumer prices rose 5.9 

percent in 2010, above the central bank’s target of 4.5 percent. In March 2011, annual inflation 

reached 6.3 percent, near the 6.5 percent upper limit of the target range. The central bank raised 

the benchmark Selic policy interest rate 200 basis points from a historical low of 8.75 percent to 

10.75 percent between April and June 2010. After holding that rate steady through the end of 

2010, the central bank initiated a further tightening cycle, raising the Selic rate by 125 basis 

points (to 12.00 percent) over three consecutive meetings through April 2011. The central bank 

also increased banks’ reserve and capital requirements to slow credit growth in December 2010, 

and, in April 2011, the Finance Ministry similarly raised taxes on consumer credit (excluding 

housing). 

Strong growth of imports and an outflow of payments on foreign investment in Brazil resulted in 

the current account deficit widening to 2.4 percent of GDP at the end of 2010. Simultaneously, 

investor confidence in future growth, strong commodity prices, and global interest rate 

differentials led to persistent strong capital inflows despite bouts of global risk aversion in the 

first quarter of 2011. 

Canada 

Canada maintains a flexible exchange rate. The Bank of Canada participated in the joint G-7 

intervention on March 18, to prevent excess volatility in the yen. The Canadian dollar 

appreciated by 5.1 percent against the U.S. dollar in 2010, and has risen an additional 5.2 percent 

through the end of April 2011. On a real effective basis, the Canadian dollar appreciated by 4.6 

percent in 2010 and a further 3.3 percent in the first four months of 2011. The appreciation of 

the Canadian dollar was driven in part by rising commodity prices as well as speculation that the 

Bank of Canada will raise interest rates ahead of the Federal Reserve. 

The Canadian economic recovery continued in 2010 with real GDP expanding by 3.1 percent, 

although the pace of growth slowed in the middle of the year before picking up again in the 

fourth quarter. The Bank of Canada is forecasting growth to moderate to 2.9 percent in 2011 and 

2.7 percent in 2012. In 2010, the main drivers of economic growth included rising commodity 

prices as well as the strengthening of private and export demand, which contributed to 8.3 

percent growth in exports by volume over 2009. Growth in 2011 is expected to be led by 

business investment, with personal consumption growing more slowly. 

Canada’s exports have been supported by rising commodity prices and the global (and 

particularly U.S.) economic recovery. Imports have also strengthened, as the rising Canadian 

dollar boosts purchasing power. Canada’s current account deficit rose to 3.1 percent of GDP in 

2010, but rising commodity prices improved Canada’s trade balance in the first quarter of 2011. 

The government has shifted its fiscal policy stance from stimulus to consolidation, targeting a 

balanced budget by the end of FY2014, down from a 2.7 percent deficit in FY2010. Citing 

robust growth and inflation pressures, in June 2010, the Bank of Canada began raising its policy 

rate; it reached 1.0 percent by September, but since then has remained unchanged. The Bank of 

Canada’s target for inflation is 2 percent. Headline inflation rose to 3.2 percent in March 2011 

23
on a year-over-year basis, in large part due to rising food and fuel prices, while core inflation 

remained contained at 1.6 percent. 

Mexico

Mexico has a flexible exchange rate and employs an inflation-targeting monetary policy regime. 

On a real effective basis, the peso appreciated by 6.0 percent during 2010 and a further 2.8 

percent in the first four months of 2011. Against the dollar, the peso appreciated by 5.7 percent 

during 2010 and 6.7 percent during the first four months of 2011. 

Mexico’s reserves increased by $22.0 billion in the year ending March 2011, to a total of $118 

billion. Most of this increase was driven by foreign exchange inflows from the state-owned oil 

company Pemex. Mexico also has continued its explicit strategy of reserve accumulation 

whereby the central bank auctions up to $600 million monthly in options to banks, which allow 

them to sell dollars to the central bank at the previous day’s exchange rate any day in the month 

that the peso 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 transparent rules-based framework. In December 2010, Mexico obtained an augmented 

precautionary Flexible Credit Line (FCL) from the IMF, equivalent to $72 billion, up from $48 

billion previously. As of the end of April 2011, Mexico had not drawn on this line. 

Real GDP expanded 5.1 percent in the fourth quarter of 2010. Growth for all of 2010 was 5.5 

percent and the Mexican government forecasts growth of 4.3 percent for 2011. Mexico’s 

recovery was initially reliant on external demand (particularly in the United States, which buys 

80 percent of Mexican exports). During the second half of 2010, growth was driven largely by 

private consumption and investment. Oil production has been flat in 2010 and the first quarter of 

2011, but manufacturing production rose sharply in the fourth quarter of 2010 and in the first 

quarter of 2011. 

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. Inflation has declined in recent 

months, reaching 3.0 percent on a year-over-year basis in March 2011, squarely in the middle of 

the central bank’s target band (2.0-4.0 percent). 

Mexico’s current account deficit was 0.5 percent of GDP in 2010, its lowest deficit since 2006. 

Rising oil export prices have been offset to a large degree by the rising cost of gasoline imports 

from the United States, while strong manufacturing export growth has been offset by rising 

volumes and prices of commodities and other imports. Exports to the United States grew 22.4 

percent in the second half of 2010, while imports from the United States grew 23.2 percent. 

   

24
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. 

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 a

a group of currencies. The weights are timevarying 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 b

major trading partners of the United States, they

do not circulate widely internationally. The 

currencies in the OITP index are: the Argentine 

peso, Brazilian real, Chilean peso, Chinese 

renminbi, Colombian peso, Korean won, Hong 

Kong dollar, Indian rupee, Indonesian rupiah, 

Israeli shekel, Malaysian ringgit, Mexican peso, Philippine peso, Russian ruble, Saudi riyal, 

Singapore dollar, Taiwan dollar, Thai baht, and Venezuelan bolívar. Current weights are given 

in the tables. For weights in all years see: http://www.federalreserve.gov/releases/H10/Weights/ 

gainst 

y 

Floating (Flexible) Exchange Rate – A regime under which the foreign exchange rate of a 

currency is fully determined by the market with intervention from the government or central 

bank being used sparingly. 

Weights in OITP Index

Country or

Region 2010

Mexico 18.74

China 34.94

Taiwan 4.79

Korea 6.83

Singapore 3.72

Hong Kong 2.50

Malaysia 3.50

Brazil 4.08

Thailand 2.69

Philippines 1.17

Indonesia 1.92

India 3.08

Israel 2.28

Saudi Arabia 1.94

Russia 2.84

Argentina 1.10

Venezuela 1.07

Chile 1.65

Colombia 1.15

Total 100

Weights in the Major  Index

Country or

Region 2010

Euro area 36.56

Canada 30.21

Japan 16.98

United Kingdom 8.49

Switzerland 3.15

Australia 2.63

Sweden 1.97

Total 100

25
26

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, 

SDRs, and foreign currency (most of which are held in short-term government securities). The 

latter are used for intervention in the foreign exchange markets. 

Intervention -- The purchase or sale of a country’s currency in the foreign exchange market by a 

government entity (typically 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 particularly 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, 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.