Eli5: What does devaluation of a currency mean? How does deliberate devaluation helps a country economically?


Eli5: What does devaluation of a currency mean? How does deliberate devaluation helps a country economically?

In: Economics

yes it helps, as far as I know, the state is getting money after all with it. it is somehow a relatively ethical method instead of higher taxes as everybody is ‘paying’ it according to how much money they have. but it’s far no perfect.

The lower the value of your currency, means you exports become easier to buy. Devaluing your currency is a good way to keep the economy running and grow exports.

Unfortunately, it also has the opposite effect that getting imports will be more costly. So if you need a lot of imports to run your country, thats bad, but if you are a big exporter, thats good

Makes it easier for a country’s producers to export because goods produced domestically are cheaper in foreign currency terms.

Many countries have a floating exchange rates. The central bank or government may “declare” some kind of desired exchange rate and can intervene (buy and sell currency) in the market to obtain that exchange rate. Devaluation, in one sense, means that the government will no longer intervene in the market when the currency weakens.

Fewer countries have pegged exchange rates. A pegged rate means that the government will promise to exchange local currency for foreign currency at a fixed exchange rate. In this case, devaluation is simply adjusting this promised rate.

There are other policies that a government can take to devalue their currency indirectly; the most common ones being to decrease the interest rate and/or increase the money supply.

Devaluation means a currency is worth less than it was. If I exchange my pounds for dollars or euros I don’t get as many as I used to. It has the effect of making imports more expensive and exports cheaper.

It’s generally done – or happens due to the market – when a country has a balance of payments deficit. This means it’s importing more than it exports. This drains reserves of foreign currencies, gold, and potentially anything else that can be sold off to other countries. If these reserves run out you’re in big trouble.

By discouraging imports and encouraging exports devaluation can balance things. The main cost is that imports cost more, potentially increasing costs for consumers, industries that need imports, etc..

(The flipside of this is that a country with a persistent balance of payments surplus is missing out on domestic consumption or investment.)

There are other things a country can do that have the effect of devaluing a currency – eg. reducing interest rates – but since devaluation is a side-effect not the main purpose I won’t go into them.

If I have $5 and want to buy a beer in Britain, I’m going to have to exchange the $5 for £3.65, and then give that money to the store owner, since he won’t take dollars. Usually, the ratio of that exchange is based on market forces: if lots of Americans want to buy British products, they are going to try to outbid each other when offering to exchange dollars for pounds, and the value of the pound will go up with respect to the dollar.

If a government wants, they could interfere by “pegging” their currency to another at a set exchange rate, saying “We are going to buy pounds for $2 each, no matter what.” Then, the value of $5 would decrease from £3.65 to £2.50. The economic advantage of this is that Americans are less likely to buy the British beer that just got more expensive for them, and buy local instead. And British people suddenly are getting a discount if they decide to buy American electronics, so they will import more from American manufacturers. It leads to a temporary boost to local industry, but also risks inflation and other financial problems.