Currency appreciation and depreciation: Difference between revisions

Currency depreciation is the loss of value of a country's currency with respect to one or more foreign reference currencies, typically in a floating exchange rate system in which no official currency value is maintained.^[1] Currency appreciation in the same context is an increase in the value of the currency.

Causes

In a floating exchange rate system, a currency's value goes up (or down) if the demand for it goes up more (or less) than the supply does. In the short run this can happen unpredictably for a variety of reasons, including the balance of trade, speculation, or other factors in the international capital market. For example, a surge in purchases of foreign goods by home country residents will cause a surge in demand for foreign currency with which to pay for those goods, causing a depreciation of the home currency.

Another cause of appreciation or depreciation of a currency is speculative movements of funds in the belief that a currency is over or under valued, as the case may be, and in anticipation of a “correction”. Such movements may in themselves cause the value of a currency to change.

A longer-run trend of appreciation (or depreciation) is likely to be caused by home country inflation being lower (or higher) on average than inflation in other countries, according to the principle of long-run purchasing power parity.

Economic effects

When a country's currency appreciates in relation to foreign currencies, foreign goods become cheaper in the domestic market and there is overall downward pressure on domestic prices. In contrast, the prices of domestic goods paid by foreigners go up, which tends to decrease foreign demand for domestic products. A depreciation of the home currency has the opposite effects.

In addition, depreciation of a currency tends to beneficially affect a country’s balance of trade by improving the competiveness of domestic goods in foreign markets while making foreign goods less competitive in the domestic market by becoming more expensive.

In the international capital market, the appreciation of the domestic currency raises the value of financial instruments denominated in that currency.

See also

References