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Feb 26 2015

Currency devaluation definition and types

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     Money is the main means of payment in the world. Each country (except some) has its own national money. The purchasing power of national money depends on their rate of foreign currencies. Let’s look at the impact of currency devaluation exchange rate on economy.

Devaluation definition.

Devaluation is the depreciation of the national currency foreign exchange rates against reserve currencies of the world.

Also, we need to pay attention to what is the foreign exchange market, because it is often determined exchange rates.

World foreign exchange market definition.

World currency exchange market is a complex of international relations that arise in the process of foreign exchange in the world scale.

The dominant currencies of the world are the US dollar and the euro.

Approximately 60-70% of all foreign exchange reserves of the world remain in US dollars, 20-30% – in Euros and 5-10% – in other currencies (Japanese yen, British pound sterling).

Given this can be generalized to say that devaluation is a reducing of national currency exchange rate against rate of major reserve world currencies.

Devaluation can have various causes, among which the main ones are the country’s balance of payments deficit, domestic inflation, political factors etc.

Devaluation may have a different tempo. Devaluation can be classified according to its tempo as the following:

  • Smooth devaluation – depreciation of up to 5% per year.
  • Moderate devaluation – depreciation is 5-15% per year.
  • Rapid devaluation – depreciation of 15-25% per year.
  • Galloping devaluation – depreciation of more than 25% per year.

Let’s look at the influence of each type of devaluation on the economy.

  1. Smooth devaluation has virtually no effect on the economy because its value does not go beyond the average exchange rate fluctuations.
  2. Moderate devaluation stimulates exports because product prices in foreign currency moderately reduced. Economy feels a relatively small impact of import cost rising at the same time.
  3. Rapid devaluation stimulates exports, but domestic consumers are starting to feel a significant increase in the value of imports. Rapid depreciation can be appropriate for countries where there are positive trade and balance of payments, because in this case the benefits of increased exports cover losses of imports cost rise.
  4. Galloping devaluation is destructive to the national economy and it is one of the main economic risks. When galloping devaluation exporters reduce exports, and eventually stop all exports, as they begin to expect stabilization of the exchange rate.

On the other hand, such situation sharply reduces effective demand for imports, because imports become more expensive very quickly.

Galloping devaluation also has a significant bad impact on the national banking system and devalues businesses and individuals savings in the national currency.

    In general we can say that a smooth devaluation of currency could even be considered as a factor of economic growth, while galloping devaluation should be considered as a factor of economic crisis, so foreign exchange policy of any country must be very prudent.

2 comments
  1. Hosting

    The devaluation of currencies arises in many situations, but comes about due to specific government action.

  2. Fitzjerald

    Unfortunately even most stable currencies in the world, such as US dollar or Euro, have some devaluation every year.

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