Depreciation
When a currency depreciates, this
means that the currency has decreased in value when compared to another
nation’s currency.
Depreciation happens in countries with a floating
exchange rate. A floating exchange rate means that the global investment market
determines the value of a country's currency. The exchange rate among various
currencies changes every day as investors reevaluate new information. While a
country's government and central bank can try to influence its exchange rate
relative to other currencies, in the end it is the free market that determines
the exchange rate. As of 2012, all major economies use a floating exchange
rate. Depreciation occurs when a country's exchange rate goes down in the
market. The country's money has less purchasing power in other countries
because of the depreciation.
Devaluation
Devaluation of currency is an active
economic strategy. It is sometimes used when countries are badly in debt. This
occurs when a country lowers the official value of its currency in relation to
foreign currencies. This is intended to raise the price of imported goods and
increase the value of the country's exported goods. This can be a risky
economic move because it can spark hyperinflation.
Devaluation happens in countries with a fixed
exchange rate. In a fixed-rate economy, the government decides what its
currency should be worth compared with that of other countries. The government
pledges to buy and sell as much of its currency as needed to keep its exchange
rate the same. The exchange rate can change only when the government decides to
change it. If a government decides to make its currency less valuable, the change
is called devaluation. Fixed exchange rates were popular before the Great
Depression but have largely been abandoned for the more flexible floating
rates. China was the last major economy to openly use a fixed exchange rate. It
switched to a floating system in 2005.