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In
macroeconomics Macroeconomics (from the Greek prefix ''makro-'' meaning "large" + ''economics'') is a branch of economics dealing with performance, structure, behavior, and decision-making of an economy as a whole. For example, using interest rates, taxes, and ...
and modern
monetary policy Monetary policy is the policy adopted by the monetary authority of a nation to control either the interest rate payable for federal funds, very short-term borrowing (borrowing by banks from each other to meet their short-term needs) or the money s ...
, a devaluation is an official lowering of the value of a country's
currency A currency, "in circulation", from la, currens, -entis, literally meaning "running" or "traversing" is a standardization of money in any form, in use or circulation as a medium of exchange, for example banknotes and coins. A more general ...
within a fixed exchange-rate system, in which a
monetary authority In finance and economics, a monetary authority is the entity that manages a country’s currency and money supply, often with the objective of controlling inflation, interest rates, real GDP or unemployment rate. With its monetary tools, a m ...
formally sets a lower
exchange rate In finance, an exchange rate is the rate at which one currency will be exchanged for another currency. Currencies are most commonly national currencies, but may be sub-national as in the case of Hong Kong or supra-national as in the case of t ...
of the national currency in relation to a foreign reference currency or
currency basket A currency basket is a portfolio of selected currencies with different weightings. A currency basket is commonly used by investors to minimize the risk of currency fluctuations and also governments when setting the market value of a country’s ...
. The opposite of devaluation, a change in the exchange rate making the domestic currency more expensive, is called a '' revaluation''. A monetary authority (e.g., a
central bank A central bank, reserve bank, or monetary authority is an institution that manages the currency and monetary policy of a country or monetary union, and oversees their commercial banking system. In contrast to a commercial bank, a centra ...
) maintains a fixed value of its currency by being ready to buy or sell foreign currency with the domestic currency at a stated rate; a devaluation is an indication that the monetary authority will buy and sell foreign currency at a lower rate. However, under a
floating exchange rate In macroeconomics and economic policy, a floating exchange rate (also known as a fluctuating or flexible exchange rate) is a type of exchange rate regime in which a currency's value is allowed to fluctuate in response to foreign exchange ma ...
system (in which exchange rates are determined by market forces acting on the
foreign exchange market The foreign exchange market (Forex, FX, or currency market) is a global decentralized or over-the-counter (OTC) market for the trading of currencies. This market determines foreign exchange rates for every currency. It includes all as ...
, and not by government or central bank policy actions), a decrease in a currency's value relative to other major currency benchmarks is instead called ''
depreciation In accountancy, depreciation is a term that refers to two aspects of the same concept: first, the actual decrease of fair value of an asset, such as the decrease in value of factory equipment each year as it is used and wear, and second, the ...
''; likewise, an increase in the currency's value is called '' appreciation''. Related but distinct concepts include ''
inflation In economics, inflation is an increase in the general price level of goods and services in an economy. When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation corresponds to a reduct ...
'', which is a market-determined decline in the value of the currency in terms of goods and services (related to its purchasing power). Altering the face value of a currency without reducing its exchange rate is a
redenomination In monetary economics, redenomination is the process of changing the face value of banknotes and coins in circulation. It may be done because inflation has made the currency unit so small that only large denominations of the currency are in c ...
, not a devaluation or revaluation.


Historical usage

Devaluation is most often used in a situation where a currency has a defined value relative to the baseline. Historically, early currencies were typically
coin A coin is a small, flat (usually depending on the country or value), round piece of metal or plastic used primarily as a medium of exchange or legal tender. They are standardized in weight, and produced in large quantities at a mint in order ...
s, struck from gold or silver by an issuing authority, which certified the
weight In science and engineering, the weight of an object is the force acting on the object due to gravity. Some standard textbooks define weight as a vector quantity, the gravitational force acting on the object. Others define weight as a scalar qua ...
and purity of the precious metal. A government in need of money and short on precious metals might decrease the weight or purity of the coins without any announcement, or else decree that the new coins have equal value to the old, thus devaluing the currency. Later, with the issuing of paper currency as opposed to coins, governments decreed them to be redeemable for gold or silver (a
gold standard A gold standard is a monetary system in which the standard economic unit of account is based on a fixed quantity of gold. The gold standard was the basis for the international monetary system from the 1870s to the early 1920s, and from th ...
). Again, a government short on gold or silver might devalue by decreeing a reduction in the currency's redemption value, reducing the value of everyone's holdings.


Causes

Fixed exchange rates are usually maintained by a combination of legally enforced capital controls and the
central bank A central bank, reserve bank, or monetary authority is an institution that manages the currency and monetary policy of a country or monetary union, and oversees their commercial banking system. In contrast to a commercial bank, a centra ...
standing ready to purchase or sell domestic currency in exchange for foreign currency. Under fixed exchange rates, persistent capital outflows or trade deficits will involve the central bank using its foreign exchange reserves to buy domestic currency, to prop up demand for the domestic currency and thus to prop up its value. However, this activity is limited by the amount of foreign currency reserves the central bank owns; the prospect of running out of these reserves and having to abandon this process may lead a central bank to devalue its currency in order to stop the foreign currency outflows. In an open market, the perception that a devaluation is imminent may lead speculators to sell the currency in exchange for the country's foreign reserves, increasing pressure on the issuing country to make an actual devaluation. When speculators buy out all of the foreign reserves, a
balance of payments crisis A currency crisis is a type of financial crisis, and is often associated with a real economic crisis. A currency crisis raises the probability of a banking crisis or a default crisis. During a currency crisis the value of foreign denominated de ...
occurs. Economists
Paul Krugman Paul Robin Krugman ( ; born February 28, 1953) is an American economist, who is Distinguished Professor of Economics at the Graduate Center of the City University of New York, and a columnist for ''The New York Times''. In 2008, Krugman was t ...
and Maurice Obstfeld present a theoretical model in which they state that the balance of payments crisis occurs when the real exchange rate (exchange rate adjusted for relative price differences between countries) is equal to the nominal exchange rate (the stated rate). In practice, the onset of crisis has typically occurred after the real exchange rate has depreciated below the nominal rate. The reason for this is that speculators do not have perfect information; they sometimes find out that a country is low on foreign reserves well after the real exchange rate has fallen. In these circumstances, the currency value will fall very far very rapidly. This is what occurred during the 1994 economic crisis in Mexico.


Economic implications

There are significant economic consequences for the country that devalues its currency to address its economic problems. A devaluation in the exchange rate lowers the value of the domestic currency in relation to all other countries, most significantly with its major trading partners. It can assist the domestic economy by making
export An export in international trade is a good produced in one country that is sold into another country or a service provided in one country for a national or resident of another country. The seller of such goods or the service provider is a ...
s less expensive, enabling exporters to more easily compete in the foreign markets. It also makes
import An import is the receiving country in an export from the sending country. Importation and exportation are the defining financial transactions of international trade. In international trade, the importation and exportation of goods are limited ...
s more expensive, providing a disincentive for domestic consumers to purchase imported goods, leading to lower levels of imports (which can benefit domestic producers),The United States and China may be headed for a currency war
/ref> but which reduces the real income of consumers. Devaluation tends to improve a country's
balance of trade The balance of trade, commercial balance, or net exports (sometimes symbolized as NX), is the difference between the monetary value of a nation's exports and imports over a certain time period. Sometimes a distinction is made between a balance ...
(exports minus imports) by improving the competitiveness of domestic goods in foreign markets while making foreign goods less competitive in the domestic market by becoming more expensive. The combined effect will be to reduce or eliminate the previous net outflow of foreign currency reserves from the central bank, so if the devaluation has been to a great enough extent the new exchange rate will be maintainable without foreign currency reserves being depleted any further. However, the devaluation increases the prices of imported goods in the domestic economy, thereby fueling
inflation In economics, inflation is an increase in the general price level of goods and services in an economy. When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation corresponds to a reduct ...
. This, in turn, increases the costs in the domestic economy, including demands for wage increases, all of which eventually flow into exported goods. These dilute the initial economic boost from the devaluation itself. Also, to combat inflation, the central bank would increase interest rates, hitting economic growth. A devaluation could also result in an outflow of capital and economic instability. In addition, a domestic devaluation merely shifts the economic problem to the country's major trading partners, which may take counter-measures to offset the impact on their economy arising out of a loss of trade income arising from the initial devaluation.


Devaluations in modern economies


UK economy


1949 devaluation

At the outbreak of
World War II World War II or the Second World War, often abbreviated as WWII or WW2, was a world war that lasted from 1939 to 1945. It involved the World War II by country, vast majority of the world's countries—including all of the great power ...
, in order to stabilise sterling, the
pound sterling Sterling (abbreviation: stg; Other spelling styles, such as STG and Stg, are also seen. ISO code: GBP) is the currency of the United Kingdom and nine of its associated territories. The pound ( sign: £) is the main unit of sterling, and ...
was pegged to the
United States dollar The United States dollar ( symbol: $; code: USD; also abbreviated US$ or U.S. Dollar, to distinguish it from other dollar-denominated currencies; referred to as the dollar, U.S. dollar, American dollar, or colloquially buck) is the officia ...
at the rate of $4.03 with exchange controls restricting
convertibility Convertibility is the quality that allows money or other financial instruments to be converted into other liquid stores of value. Convertibility is an important factor in international trade, where instruments valued in different currencies mus ...
volumes. This rate was confirmed by the Bretton Woods agreements of 1944. After the war, US
Lend-Lease Lend-Lease, formally the Lend-Lease Act and introduced as An Act to Promote the Defense of the United States (), was a policy under which the United States supplied the United Kingdom, the Soviet Union and other Allied nations with food, oil, ...
funding, which had helped finance the UK's high level of wartime expenditure, abruptly ended and the Anglo-American loan was conditional upon progress towards sterling becoming fully convertible into US dollars, thereby aiding US trade. In July 1947, sterling became convertible but the resultant drain on the UK's foreign exchange reserves of US dollars was such that 7 weeks later, convertibility was suspended,
rationing Rationing is the controlled distribution of scarce resources, goods, services, or an artificial restriction of demand. Rationing controls the size of the ration, which is one's allowed portion of the resources being distributed on a particular ...
tightened and expenditure cuts made. The exchange rate reverted to its pre-convertibility level, a devaluation being avoided by the new Chancellor of the Exchequer,
Stafford Cripps Sir Richard Stafford Cripps (24 April 1889 – 21 April 1952) was a British Labour Party politician, barrister, and diplomat. A wealthy lawyer by background, he first entered Parliament at a by-election in 1931, and was one of a handful of La ...
, choking off consumption by increasing
taxes A tax is a compulsory financial charge or some other type of levy imposed on a taxpayer (an individual or legal entity) by a governmental organization in order to fund government spending and various public expenditures (regional, local, o ...
in 1947. By 1949, in part due to a dock strike, the pressure on UK reserves supporting the fixed exchange rate mounted again at a time when Cripps was seriously ill and recuperating in Switzerland.Beckett p278 Prime Minister
Clement Attlee Clement Richard Attlee, 1st Earl Attlee, (3 January 18838 October 1967) was a British politician who served as Prime Minister of the United Kingdom from 1945 to 1951 and Leader of the Labour Party from 1935 to 1955. He was Deputy Prime Mini ...
delegated a decision on how to respond to three young ministers whose jobs included economic portfolios, namely
Hugh Gaitskell Hugh Todd Naylor Gaitskell (9 April 1906 – 18 January 1963) was a British politician who served as Leader of the Labour Party and Leader of the Opposition from 1955 until his death in 1963. An economics lecturer and wartime civil servant ...
,
Harold Wilson James Harold Wilson, Baron Wilson of Rievaulx, (11 March 1916 – 24 May 1995) was a British politician who served as Prime Minister of the United Kingdom twice, from October 1964 to June 1970, and again from March 1974 to April 1976. He ...
and Douglas Jay, who collectively recommended devaluation. Wilson was despatched with a letter from Attlee to tell Cripps of their decision, expecting that the Chancellor would object, which he did not. On 18 September 1949, the exchange rate was reduced from $4.03 to $2.80 and a series of supporting public expenditure cuts imposed soon afterwards.


1967 devaluation

When the Labour Government of Prime Minister
Harold Wilson James Harold Wilson, Baron Wilson of Rievaulx, (11 March 1916 – 24 May 1995) was a British politician who served as Prime Minister of the United Kingdom twice, from October 1964 to June 1970, and again from March 1974 to April 1976. He ...
came to power in 1964, the new administration inherited an economy in a more precarious state than expected with the estimated balance of payments deficit for the year amounting to £800 million, twice as high as Wilson had predicted during the election campaign. Wilson was opposed to devaluation, in part due to the bad memories of the 1949 devaluation and its negative impact on the
Attlee Clement Richard Attlee, 1st Earl Attlee, (3 January 18838 October 1967) was a British politician who served as Prime Minister of the United Kingdom from 1945 to 1951 and Leader of the Labour Party (UK), Leader of the Labour Party from 1935 t ...
government, but also due to the fact that he had repeatedly asserted that Labour was not the party of devaluation. Devaluation was avoided by a combination of tariffs and raising $3bn from foreign central banks. By 1966, pressure on sterling was intensifying, due in part to the seamen's strike, and the case for devaluation being articulated in the higher echelons of government, not least by the deputy prime minister George Brown. Wilson resisted and eventually pushed through a series of deflationary measures in lieu of devaluation including a 6 month wage freeze. After a brief period in which the deflationary measures relieved sterling, pressure mounted again in 1967 as a consequence of the
Six-Day War The Six-Day War (, ; ar, النكسة, , or ) or June War, also known as the 1967 Arab–Israeli War or Third Arab–Israeli War, was fought between Israel and a coalition of Arab states (primarily Egypt, Syria, and Jordan) from 5 to 10 ...
, the Arab oil embargo and a dock strike. After failing to secure a bail-out from the Americans or the French, a devaluation from US$2.80 to US$2.40 took effect on 18 November 1967. In a broadcast to the nation the following day, Wilson said, "Devaluation does not mean that the value of the pound in the pocket in the hands of the … British housewife … is cut correspondingly. It does not mean that the pound in the pocket is worth 14% less to us now than it was." This wording is often misquoted as "the pound in your pocket has not been devalued." Nevertheless the devaluation forced
James Callaghan Leonard James Callaghan, Baron Callaghan of Cardiff, ( ; 27 March 191226 March 2005), commonly known as Jim Callaghan, was Prime Minister of the United Kingdom from 1976 to 1979 and Leader of the Labour Party from 1976 to 1980. Callaghan is ...
to resign as
Chancellor of the Exchequer The chancellor of the Exchequer, often abbreviated to chancellor, is a senior minister of the Crown within the Government of the United Kingdom, and head of HM Treasury, His Majesty's Treasury. As one of the four Great Offices of State, the Ch ...
, making way for
Roy Jenkins Roy Harris Jenkins, Baron Jenkins of Hillhead, (11 November 1920 – 5 January 2003) was a British politician who served as President of the European Commission from 1977 to 1981. At various times a Member of Parliament (MP) for the Lab ...
.


Other economies

The People's Bank of China devalued the
renminbi The renminbi (; symbol: ¥; ISO code: CNY; abbreviation: RMB) is the official currency of the People's Republic of China and one of the world's most traded currencies, ranking as the fifth most traded currency in the world as of April 202 ...
twice within two days by 1.9% and 1% in July 2015 in response to slowing economic growth, leading to the 2015–2016 Chinese stock market turbulence. Although the devaluation was welcomed by the
International Monetary Fund The International Monetary Fund (IMF) is a major financial agency of the United Nations, and an international financial institution, headquartered in Washington, D.C., consisting of 190 countries. Its stated mission is "working to foster glo ...
, it led the
United States Department of the Treasury The Department of the Treasury (USDT) is the national treasury and finance department of the federal government of the United States, where it serves as an executive department. The department oversees the Bureau of Engraving and Printing and ...
to label China as a currency manipulator in 2019. On 5 August 2019, China devalued its currency in response to the imposition of trade tariffs by the United States against China. India devalued the
Indian rupee The Indian rupee ( symbol: ₹; code: INR) is the official currency in the republic of India. The rupee is subdivided into 100 '' paise'' (singular: ''paisa''), though as of 2022, coins of denomination of 1 rupee are the lowest value in use ...
by 35% in 1966. Mexico devalued the
Mexican peso The Mexican peso ( symbol: $; code: MXN) is the currency of Mexico. Modern peso and dollar currencies have a common origin in the 16th–19th century Spanish dollar, most continuing to use its sign, "$". The current ISO 4217 code for the ...
against the U.S. Dollar in 1994 in preparation for the
North American Free Trade Agreement The North American Free Trade Agreement (NAFTA ; es, Tratado de Libre Comercio de América del Norte, TLCAN; french: Accord de libre-échange nord-américain, ALÉNA) was an agreement signed by Canada, Mexico, and the United States that crea ...
, leading to the Mexican peso crisis.


See also

*
Currency appreciation and depreciation Currency depreciation is the loss of value of a country's currency with respect to one or more foreign reference currencies, typically in a floating exchange rate system in which no official currency value is maintained. Currency appreciatio ...
*
Beggar thy neighbour In economics, a beggar-thy-neighbour policy is an economic policy through which one country attempts to remedy its economic problems by means that tend to worsen the economic problems of other countries. Adam Smith made reference to the term in ...
*
Currency war Currency war, also known as competitive devaluations, is a condition in international affairs where countries seek to gain a trade advantage over other countries by causing the exchange rate of their currency to fall in relation to other curr ...
* Debasement * Deflation * Fixed exchange rate *
Inflation In economics, inflation is an increase in the general price level of goods and services in an economy. When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation corresponds to a reduct ...
*
Internal devaluation Internal devaluation is an economic and social policy option whose aim is to restore the international competitiveness of some country mainly by reducing its labour costs – either wages or the indirect costs of employers. Sometimes internal deva ...
*
Monetary policy Monetary policy is the policy adopted by the monetary authority of a nation to control either the interest rate payable for federal funds, very short-term borrowing (borrowing by banks from each other to meet their short-term needs) or the money s ...
* Revaluation * Store of value


References


External links


Economics A-Z
{{Authority control Monetary policy