Devaluation and Depreciation Definition

Definition of devaluation and depreciation

  • A devaluation occurs when a country makes a conscious decision to lower its exchange rate in a fixed or semi-fixed exchange rate.
  • A depreciation is when there is a fall in the value of a currency in a floating exchange rate.

In general, everyday use, devaluation and depreciation are often used interchangeably. They both have the same effect. – A fall in the value of the currency which makes imports more expensive, and exports more competitive.

depreciation-definition

In 2008, the Pound Sterling fell in value by 30%. The correct term is a depreciation because the Pound Sterling was a floating currency (no fixed exchange rate.)

  • For A Level economics, it is not absolutely essential to distinguish between the two, but there is a distinct technical 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

sterling-index-june-24-16
Sterling exchange rate index, which shows the value of Sterling against a basket of currencies. In 1992, The Pound devalued after exiting the Exchange Rate Mechanism.

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. In 1992, they left ERM as they couldn’t maintain the value of Pound.

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, After Brexit vote of 2016, the value of Pound Sterling fell 15% because investors downgraded the long-term economic outlook of the UK.

Everyday use

In everyday use, people talk about a devaluation of Sterling/Dollar when, technically speaking, they mean a depreciation in Sterling/US Dollar.

Related

19 thoughts on “Devaluation and Depreciation Definition

  1. 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.

    1. 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

Leave a Reply

Your email address will not be published. Required fields are marked *