What Is Devaluation?
Devaluation (devaluation, from Latin de – decrease and valeo – to be worth) is the reduction of a country’s national currency value relative to commonly accepted reserve and stable currencies, as well as the global monetary standard, and a decrease in real gold content.
In simple terms, devaluation is the process of reducing the value of a national currency compared to other currencies.
History of Devaluation
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Devaluation in the sense we understand it today appeared relatively recently. Previously, before the second half of the 20th century, the term had a different meaning. When the gold standard existed, the currencies of all countries were tied to gold, so a reduction in the direct gold content of the currency was called “devaluation.” For example, if at the end of the 19th century a ruble could be bought for 1.5 grams of gold, later after devaluation, it would only be worth 0.77 grams.
Today, hard reserve currencies like the euro or dollar take the role of gold, so the currencies of other countries are devalued against them.
Who Declares Devaluation?
Devaluation is a tool used by a country’s central bank to manage the exchange rate of its national currency, which is determined by economic policy. For example, the Central Bank of Russia influences the ruble’s exchange rate through large-scale purchases or sales of foreign currency.
Devaluation can be a very convenient way to replenish the budget, especially for exporting countries. A weak national currency, when converted into dollars, which are mainly used for transactions, can significantly increase the budget. Similarly, by devaluing the currency, the government can support its domestic producers who export goods and services.
Why Is Devaluation Declared?
Causes for declaring devaluation may include:
- Balance of payments deficit
- High inflation rates
As part of the decision to devalue, the central bank may implement the following measures:
- Announce the abandonment of supporting the national currency exchange rate;
- Officially lower the exchange rate of the national currency;
- Announce the cancellation of the link between the national currency exchange rate and other currencies;
These measures aim to stimulate domestic production and increase the competitiveness of domestically produced goods on foreign markets.
What Types of Devaluation Exist?
Devaluation can be of two types: open and hidden.
- Open Devaluation. The central bank of the country announces an official reduction in the exchange rate of the national currency, removes old banknotes from circulation, and introduces new ones.
- Hidden Devaluation. The central bank of the country reduces the exchange rate of the national currency using all available methods, but the devalued money is not removed from circulation.
How Is Devaluation Different From Inflation?
Inflation always accompanies devaluation. The essence of these concepts is largely similar, but inflation represents a decrease in the purchasing power of the national currency on the domestic market, while devaluation refers to a decrease in the purchasing power of the currency relative to other currencies.
Devaluation acts as a trigger for inflation. Due to the depreciation of the national currency, producers are forced to raise prices on their products, thus increasing the rate of inflation.
It is important to understand that the main difference between inflation and devaluation is that inflation is a difficult-to-control and often spontaneous process, while devaluation is a deliberate measure taken by the central bank.
What Are the Pros and Cons of Devaluation?
Any form of devaluation has both positive and negative consequences.
Benefits of Devaluation:
- Increased demand for domestically produced goods on the internal market;
- Reduced rate of expenditure of GFE reserves of the state;
- Boosts exports of domestic goods to foreign markets.
Drawbacks of Devaluation:
- Increases the rate of consumer inflation;
- Loss of trust in the national currency;
- Reduces import volumes, as the price of imported goods constantly rises, causing a slowdown in production that uses foreign technologies and materials;
- Depreciation of bank deposits in the national currency;
- Decreased purchasing power and activity of the population due to reduced wages and social benefits.
FAQ
What is the main cause of currency devaluation?
The main causes of currency devaluation include balance of payments deficits and high inflation rates.
How does devaluation affect the economy?
Devaluation can boost exports and domestic production but may also lead to higher inflation and loss of public confidence in the currency.
What is the difference between devaluation and inflation?
Devaluation refers to a decrease in the value of a currency relative to others, while inflation is a decrease in the purchasing power of a currency within the domestic market.
