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

17 thoughts on “Devaluation and Depreciation Definition

  1. depreciation and appreciation is for floating exchange rate
    and devaluation and revaluation is only for fixed exchange rate 🙂
    hope that helps

  2. 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.

  3. 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

  4. 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

    1. 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.

  5. 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.

  6. 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

  7. I can see that,devaluation is an intentional act by tube government as a measure of removing or correction disequilibrium in the BOP. It’s done under fixed exchange rate.
    Depreciation on the other hand occurs as a result of external pressure by other foreign currencies making the domestic currency to loose value. The government has no contribute on it. It happens under flexible exchanging rate.
    Any different thought please!

Leave a Reply

Your email address will not be published.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