Definition of devaluation and depreciation
Readers Question: I read in a text-book that under a floating exchange rate a “devaluation” is not possible as a means of improving international competitiveness but a “depreciation” is. Could you please explain to me what a depreciation is as opposed to a devaluation.
Interesting question.
In general, everyday use, devaluation and depreciation are often used interchangeably. In fact for A Level economics it is not essential to distinguish between the two (but, there is a distinct different)
Definition of Devaluation:
A devaluation is when a country makes a conscious decision to lower its exchange rate in a fixed or semi fixed exchange rate. Therefore, technically a devaluation is only possible if a country is a member of some fixed exchange rate policy.
- For example in the late 1980s, the UK joined the Exchange Rate Mechanism ERM. Initially the value of the Pound was set between say 3DM and 3.2DM. However, if the government thought that was too high, they could make the decision to devalue and change the target exchange rate to 2.7DM and 2.9DM.
Definition of depreciation: When there is a fall in the value of a currency in a floating exchange rate. This is not due to a government’s decision, but due to supply and demand side factors. Although if the government sold a lot of pounds they could help the depreciation.
For example, the dollar has depreciated in value against the Euro during the last 12 months. This is due to market forces, there is no fixed exchange rate target for Euro to Dollar.
The problem is that in ever-day use, people take about a devaluation in the dollar, when actually they technically speaking mean a depreciation in the dollar.
Related
Devaluation is a mechanism which involves government influence in determining the exchange rate in a fixed exchange rate system.Depreciation is a deliberate fall of value on local currency against foreign currence without the intervention of goernment.
appreciation associated with flexible ER……and Devaluation & revaluation associated with fixwd ER…..got it u allllll………………
more simply, devaluation is manual… depreciation is automatic!
hope that makes it somewhat clearer.
please comment on that
In simple words devaluation is the official decrease in the value of a currency. while depreciation does not necessarily involve the intentional act on the part of government to reduce the value of currency.
Hope it z more clear picture.
thanks
hello,
i read now in an article “This highlights
the arguments among those who
believe that exchange rate devaluation is preferable to
internal devaluation”
ok , like before exchange rate devaluation is explained with fixed currency,
but what is INTERNAL DEVALUATION?
Is it depreciation ? but it makes no sense togehter with the word INTERNAL, as it is EXTERNAL market driven.
Sorry , I am not a native English.
thanks
Tejan- last paragraph: take>talk
L Chibika- like a razor.
Chris- exchange rate devaluation, think: market driven forces.
“internal” devaluation, think: criminal activity.
I’d rather my money be regulated by market driven forces rather than man and his/her whim or tidy models that favor the few.
A depreciation in the external value of the currency is likely to:
a) increase inflation
b) increase the terms of trade
c) reduce the costs to business of imported raw material
d) reduce international competitiveness
my teacher doesn’t know the difference between devaluation and depreciation!
though both devaluation and depreciation imply fall in external value of a country’s currency, devaluation is taking the exchange rate from equilibrium to a disequilibrium situation; fix the exchange rate below its equilibrium value; create a situation where demand for the currency exceeds supply of the currency.
However, depreciation implies a lower equilibrium exchange rate following an increase in supply of the currency or a decrease in the demand of the currency.
thanks, friend…
advantages and desadvantages of devaluation
depreciation and appreciation is for floating exchange rate
and devaluation and revaluation is only for fixed exchange rate
hope that helps
Very tricky indeed. Depreciation remains contentious. Its application in accounting is reviewed every year!