Devaluation and Depreciation Definition

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.

In general, everyday use, devaluation and depreciation are often used interchangeably. In fact for A Level economics it is not absolutely essential to distinguish between the two, but there is a distinct difference and using them correctly is good practice.

Essentially devaluation is changing the value of a currency in a fixed exchange rate. A depreciation is reducing the value in a floating exchange rate.

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 their currency they could help cause a 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 talk about a devaluation in the dollar, when, technically speaking, they mean a depreciation in the dollar.

 

Related

19 Responses to Devaluation and Depreciation Definition

  1. Sean Goss June 19, 2008 at 1:06 am #

    Very tricky indeed. Depreciation remains contentious. Its application in accounting is reviewed every year!

  2. Young Min February 4, 2009 at 2:13 pm #

    depreciation and appreciation is for floating exchange rate
    and devaluation and revaluation is only for fixed exchange rate :)
    hope that helps

  3. kemeze francis February 9, 2009 at 2:22 pm #

    advantages and desadvantages of devaluation

  4. tania April 26, 2010 at 9:00 pm #

    thanks, friend…

  5. bhoomee May 22, 2010 at 3:50 pm #

    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.

  6. Don Nicol July 14, 2010 at 10:54 am #

    my teacher doesn’t know the difference between devaluation and depreciation!

  7. Pat September 8, 2010 at 10:58 am #

    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

  8. chris January 26, 2011 at 12:39 pm #

    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

    • collini March 8, 2013 at 12:58 pm #

      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.

  9. imran saeed August 17, 2011 at 7:37 am #

    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.

    • taj May 19, 2012 at 8:19 am #

      thanks

  10. imran saeed August 17, 2011 at 7:39 am #

    please comment on that

  11. amzer.ten August 5, 2012 at 8:12 am #

    more simply, devaluation is manual… depreciation is automatic!
    hope that makes it somewhat clearer. :)

  12. mrzee38@yahoo January 12, 2013 at 9:09 pm #

    appreciation associated with flexible ER……and Devaluation & revaluation associated with fixwd ER…..got it u allllll………………

  13. L CHIBIKA January 26, 2013 at 11:15 am #

    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.

    • otaigo elisha June 22, 2013 at 8:30 am #

      devaluation occur when the specific country devalue its currency so as to stimulate trade between and in the international trade take an example of china,these can be the decision from the government, while depreciation is the situation in which the currency loss its value but these are caused by same factors

Trackbacks/Pingbacks

  1. Floating Exchange Rate and Current Account Balance of Payments — Economics Blog - May 2, 2008

    [...] I blogged about this previously, Definition of Devalue and Depreciation [...]

  2. Internal Devaluation Definition — Economics Blog - December 14, 2010

    [...] devaluation of the currency is a decision to allow a currency, in a fixed or semi-fixed exchange rate, to [...]

  3. Understanding Exchange Rates | Economics Blog - November 3, 2011

    [...] Depreciation – fall in value of exchange rate – exchange rate becomes weaker (see also: definition of devaluation and depreciation) [...]