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Tuesday, June 7, 2011

How Currency Devaluation and Currency Depreciation are differnt ?

Devaluation and Depreciation are altogether two different concepts but are often used interchangeably.
Devaluation is the decrease in the value of a currency with respect to goods and services it can buy.
In Fixed Exchange Rate System, monetary authorities fix the value of domestic currency against another currency or a basket of currencies.
When officially sovereign currency is devalued against the pegged currency, it is called Devaluation. The concept of devaluation started when there were coins with higher intrinsic value like gold and silver coins and the government with depleting precious metal, started depreciating money to save the precious metal.
When the world migrated to fiat money, devaluation did not remain that sought-after.
Now a day, there is no major economy following this system.
Another prevalent system which is widely followed by major economies is Floating Exchange Rate System.
Economies following this system let the demand and supply at the Foreign Exchange Market determine the value of the domestic currency.
In this system when domestic currency loses value against other currencies it is called Currency Depreciation, and when reverse happens i.e. domestic currency gains value against other currencies is called Currency Appreciation.
Question arises, if all major economies are following floating exchange rate system then how come these economies devalue their currencies?
And the answer lies is Money printing or more politically appropriate word is Quantitative Easing. This is nothing but indirect way of devaluing currency.
Economies with more expenditure than the revenue have no option but to go for deficit spending and burgeoning national debt makes them devalue their currency.
Whether devaluation or depreciation both are favourable for exporters but on the other side make inports expensive.A series of devaluation/depreciation can make even a strong currency a weaker one.

2 Comments:

Ayesha said...

Avadhoot Nasikkar said...

@ Ayesha : plz dont put links to third party sites in your comments.

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