Devaluation vs Depreciation
Devaluation and depreciation are both instances when the value of a currency falls in terms of another currency, even though the manner in which this happens is quite distinct. Both these concepts evolve around foreign exchange and how the value of currencies can be affected by factors present in the international economy. These two concepts are very easily confused, and the following article provides examples and explanations on each of them as well as a comparison clearly outlining their differences.
What is Devaluation?
Devaluation of a currency happens when a country deliberately reduces the value of its currency in terms of another currency. Taking an example, if 1USD is equal to 3 Malaysian Ringgit (MYR), the US dollar is 3 times stronger than the MYR. However, if the Malaysian treasury devalues their currency, it would look something like this, 1USD = 3.5MYR. In this case, the US dollar can buy more MYR and the Malaysian consumer will have to spend more MYR to purchase goods denominated in US $.
A country may devalue their currency for a number of reasons. One of the major reasons is to boost their exports. When the value of the MYR is depreciated against the USD, the value of Malaysian goods will become cheaper in the United States, and this will stimulate higher demand for Malaysian exports.
What is Depreciation?
Depreciation of a currency occurs when the value of the currency falls as a result of the forces of demand and supply. The value of a currency will fall when the supply of the currency in the market increases for when the demand for it falls. The depreciation of a currency can be caused by a number of factors. For example, if the Indian exports of wheat fall because of an environmental issue that affects all wheat crops and the Indian rupee will depreciate in value. This is because when India exports it obtains USD and supplies the USD to obtain Indian rupees thereby creating a demand for the Indian rupee. When exports reduce, there will be a lower demand for the Indian rupee causing its value to depreciate. Currency depreciation will further reduce exports since now products are more expensive to a foreign buyer in terms of their own currency.
Devaluation vs Depreciation
Both devaluation and depreciation are similar in that they refer to the value of a currency decreasing in terms of another currency. While depreciation is done purposely for a number of reasons, depreciation occurs as a result of the forces of demand and supply. Most economists believe that allowing a currency to float may cause economic issues in the short term but will result in an economy that is more stable and solid and able to better cushion itself against market crashes because these factors are already mirrored in the movement of the currency.
Devaluation, on the other hand, is viewed as a drastic measure of control and manipulation which can result in the value of the currency being far from what it actually is. However, devaluation can help resolve economic issues in the short run.
Summary
• Devaluation and depreciation are both instances when the value of a currency falls in terms of another currency, even though the manner in which this happens is quite distinct.
• Devaluation of a currency happens when a country deliberately reduces the value of its currency in terms of another currency.
• Depreciation of a currency occurs when the value of the currency falls as a result of the forces of demand and supply.