Devaluation

What is Devaluation?

Devaluation is the deliberate downward adjustment of a country’s currency value relative to another currency, group of currencies, or a standard such as gold. This economic policy tool is used by governments to make a country’s exports more competitive in the global market and to address imbalanced trade. While devaluation can strengthen export markets by making goods and services cheaper to foreign buyers, it can also increase the cost of imports, thereby raising the price of goods and services domestically.

Examples of Devaluation

United Kingdom (1967): The British Pound was devalued by 14.3% in 1967 under Prime Minister Harold Wilson, aiming to tackle trade deficits and increase export competitiveness.
China (2015): The People’s Bank of China lowered the value of the Yuan by around 2% in August 2015 to stimulate exports and counter a weakening economy.
Argentina (2018): Struggling with high inflation and economic instability, the Argentinian government devalued the Peso significantly in a bid to improve economic conditions.

Frequently Asked Questions

Why do governments choose to devalue their currency?

Governments devalue their currency mainly to improve the trade balance by making exports cheaper and imports more expensive, thereby boosting domestic industries and reducing trade deficits.

How does devaluation differ from depreciation?

Devaluation is a deliberate action by the government in a fixed exchange rate system, while depreciation refers to a decrease in the currency’s value due to market forces in a floating exchange rate system.

What are the potential downsides of devaluation?

The primary downsides include inflation, as imports become more expensive, reduced purchasing power for citizens, and potential loss of investor confidence leading to capital flight.

How does devaluation affect inflation?

Devaluation can lead to inflation because the higher cost of imported goods and raw materials is passed on to consumers, raising overall price levels within the economy.

Is devaluation a sign of economic weakness?

Often, devaluation is employed in situations of economic stress or imbalance, such as significant trade deficits or high inflation, which might be perceived as signs of economic weakness.

Fixed Exchange Rate: A system where a currency’s value is tied to the value of another single currency or a basket of other currencies, or sometimes gold.
Floating Exchange Rate: A system where a currency’s value is allowed to fluctuate according to the foreign exchange market.
Depreciation: A fall in the value of a currency in a floating exchange rate system due to market forces.
Revaluation of Currency: The process where a country increases the value of its currency relative to other currencies in a fixed exchange rate system.

Online Resources

Suggested Books for Further Studies

“Applied International Economics” by W. Charles Sawyer and Richard L. Sprinkle
“International Economics: Theory and Policy” by Paul Krugman and Maurice Obstfeld
“Exchange-Rate Economics” by Ronald MacDonald

Accounting Basics: Devaluation Fundamentals Quiz

### Why might a government devalue its currency? - [x] To make exports cheaper and imports more expensive. - [ ] To increase the intrinsic value of domestic goods. - [ ] To stabilize the stock markets. - [ ] To create economic isolation. > **Explanation:** A government might devalue its currency to make exports cheaper, improving their competitiveness globally, and to make imports more expensive, narrowing the trade deficit. ### Which exchange rate system typically sees deliberate currency devaluation by the government? - [ ] Floating exchange rate - [x] Fixed exchange rate - [ ] Pegged exchange rate - [ ] Hybrid exchange rate > **Explanation:** Devaluation is typically associated with a fixed exchange rate system where the government can directly intervene in currency value adjustments. ### What is the main goal of devaluing a currency? - [ ] To decrease the value of domestic investments. - [x] To improve a country's export competitiveness. - [ ] To reduce government spending. - [ ] To limit immigration. > **Explanation:** The main goal of devaluing a currency is to make exports more competitive by lowering their prices for foreign buyers, thus boosting economic activity. ### How does devaluation impact the cost of imports? - [ ] Reduces the cost of imports. - [ ] Stabilizes the cost of imports. - [x] Increases the cost of imports. - [ ] Imports are unaffected. > **Explanation:** Devaluation increases the cost of imports because more of the devalued currency is now required to purchase the same amount of foreign goods and services. ### Which term describes a situation where a currency's value is determined by market forces rather than deliberate government action? - [ ] Devaluation - [x] Depreciation - [ ] Revaluation - [ ] Inflation > **Explanation:** Depreciation refers to a decrease in the value of a currency due to market forces in a floating exchange rate system, as opposed to deliberate government action like devaluation. ### What happens to a country’s trade balance when it devalues its currency? - [ ] The trade deficit widens. - [x] The trade balance improves. - [ ] There is no impact on the trade balance. - [ ] The trade surplus increases. > **Explanation:** Devaluation generally helps improve a country's trade balance by making exports cheaper and more attractive to foreign buyers and imports more expensive. ### Who typically implements a currency devaluation? - [ ] Private banks - [x] Government authorities - [ ] International investors - [ ] World Bank > **Explanation:** Currency devaluation is typically implemented by government authorities within a fixed exchange rate system. ### How might devaluation affect local consumers? - [ ] Decrease in inflation - [ ] Increase in real income - [x] Increase in the price of imported goods - [ ] Stabilize GDP growth > **Explanation:** Devaluation can lead to higher prices for imported goods, which can contribute to inflation and reduce consumers' purchasing power. ### In which year did the United Kingdom last undergo a notable currency devaluation? - [x] 1967 - [ ] 1972 - [ ] 1986 - [ ] 1994 > **Explanation:** The United Kingdom underwent a notable currency devaluation in 1967 when the British Pound was devalued by 14.3%. ### Which country devalued its currency in 2015 to boost exports? - [ ] India - [x] China - [ ] Brazil - [ ] Russia > **Explanation:** In 2015, China devalued its currency, the Yuan, by about 2% to boost exports and counteract economic weaknesses.

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