Depreciation and Devaluation are two different economic terms that actually deals with the country’s currency value. Both currency depreciation and currency devaluation end up with a currency that is worth less than it previously was in comparison to the currencies of other countries.
Depreciation of the currency happens when the country follows a flexible exchange rate. Flexible interest rate means that the value of the currency i…s determined by the demand and supply and the central bank doesn’t intervene in it.
A floating exchange rate means that the global investment market determines the value of a country’s currency. These countries allow supply and demand to determine the value of their currency relative to the currencies of other countries. Depreciation occurs when the forces of supply and demand cause the value of their currency to drop
It happens in countries with fixed exchange rate. In a fixed exchange rate , central bank decides what should be the value of its currency compared to other countries. The Central bank intervenes by buying or selling government securities to keep its exchange rates fixed.
Devaluating a currency is decided by the government issuing the currency, and unlike depreciation, is not the result of non-governmental activities. One reason a country may devaluate its currency is to combat trade imbalances. Devaluation causes a country’s exports to become less expensive, making them more competitive on the global market. This in turn means that imports are more expensive, making domestic consumers less likely to purchase them.
While devaluating a currency can seem like an attractive option, it can have negative consequences. By making imports more expensive, it protects domestic industries who may then become less efficient without the pressure of competition. Higher exports relative to imports can also increase aggregate demand, which can lead to inflation.
MECHANISM FOR DEVALUATION
A Country’s exchange rate is essentially set by the market forces. However, the Central Bank of a country can intervene in the market to effect devaluation by increasing the supply of its currency to buy other currencies, thereby causing fall in the value of its own currency.
Another way of devaluing home currency is quantitative easing which has become common in 2009 and 2010.In quantitative easing, the Central Bank of the country increases the money supply by purchasing government securities from banks. This increased money supply leads to lowering of interest rates in the economy, thereby weakening the external value of its currency.
The third method of devaluation is to talk down the value of home currency by giving hint of a future action thereby discouraging speculators from taking any position on the hope of a future rise of the currency.
Read more at: Difference Between Devaluation & Depreciation
Source Budgeting Money by Demand Media-article by David Rodeck, Demand Media