Economics Dictionary of ArgumentsHome
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| Devaluation: Devaluation in economics is the deliberate downward adjustment of a country's currency value relative to another currency, a group of currencies, or a standard like gold, within a fixed exchange rate system. It's a policy decision by a government or central bank, often aimed at making exports cheaper and imports more expensive to improve the trade balance. See also Currency, Currency policy._____________Annotation: The above characterizations of concepts are neither definitions nor exhausting presentations of problems related to them. Instead, they are intended to give a short introduction to the contributions below. – Lexicon of Arguments. | |||
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Congressional Research Service (CRS) on Devaluation - Dictionary of Arguments
CRS I 13 Devaluation/Marc Labonte/CRS: When investors recognize a situation where devaluation becomes likely, even though they may have had no intention of leaving a country otherwise, they have every incentive to remove their money before the devaluation occurs because devaluation makes the local investment worth less in foreign currency. Because the central bank’s reserves will always be smaller than liquid capital flows when capital is mobile, devaluation becomes inevitable when investors lose faith in the government’s willingness to correct the exchange rate’s misalignment. To an extent, the phenomenon then takes on the aspect of a self-fulfilling prophecy. The reason the depreciation of a currency in crisis is typically so dramatic is because at that point investors are no longer leaving because of economic fundamentals, but simply to avoid being the one “standing when the music stops.” Notice that in the textbook explanation, a currency depreciation is expected to boost growth through an improved trade balance. In a currency crisis, this does not happen at first, although it does happen eventually, because resources cannot be reallocated towards increased exports quickly enough to compensate for the blow to the economy that comes through the sudden withdrawal of capital. In the Asian crisis, businessmen told of export orders they were unable to fill following devaluation because their credit line had been withdrawn. The shock of the capital outflow is exacerbated by the tendency for banking systems to become unbalanced in fixed exchange rate regimes. When foreigners lending to the banking system start to doubt the sustainability of an exchange rate regime, they tend to shift exchange rate risk from themselves to the banking system in two ways. First, foreign investors denominate their lending in their own currency, so that the financial loss caused by devaluation is borne by the banking system. CRS I 14 Before devaluation, a bank’s assets might exceed its liabilities. With devaluation, the foreign currency liabilities suddenly multiply in value with the stroke of a pen without any physical change in the economy, and the banks become insolvent.(1) Second, foreign lending to the banking system is done on a short-term basis so that investments can be repatriated before devaluation takes place. This is problematic because most of a bank’s investments are longer term. The banks then enter a cycle where the short-term debt is rolled over until crisis strikes, at which point credit lines are cut. Both of these factors lead to a situation where a currency crisis causes a banking crisis, which is a much more significant barrier to economic recovery than the devaluation itself. These two characteristics both tend to be present when lending to developing countries even in good times; the tendencies are accelerated when booms look unsustainable. An exception may have been Brazil, which some economists have suggested recovered so quickly from its devaluation because its banking system had few short-term, foreign currency denominated assets.(2) It is not necessarily illogical for the banking system to accept financing on a short term basis or denominated in foreign currency when credit conditions tighten. If it did not accept all forms of financing available to it, it could face insolvency at worst and a significant contraction in business at best. If the banks believe that the downturn is temporary and the episode will pass without a currency devaluation, then the banks will be able to repay the loans once conditions improve. If devaluation causes them to fail, they may expect the government to bail them out, perhaps explaining their willingness to accept these currency risks. >Currency crises, >Capital controls, >Fixed exchange rates, >Floating exchange rates, >International trade, >Currency. 1. The insolvency problem occurs because, in practice, the bank does not denominate its assets in terms of the foreign currency. This is presumably because its assets are domestic loans. 2. Paul Krugman, “Crises: The Price of Globalization?” paper presented at Federal Reserve Bank of Kansas City symposium, August 2000. Congressional Research Service of the Library of congress (CRS) Fixed Exchange Rates and Floating Exchange Rates: What Have We Learned? RL31204 (2007) https://www.congress.gov/crs-product/RL31204_____________Explanation of symbols: Roman numerals indicate the source, arabic numerals indicate the page number. The corresponding books are indicated on the right hand side. ((s)…): Comment by the sender of the contribution. Translations: Dictionary of Arguments The note [Concept/Author], [Author1]Vs[Author2] or [Author]Vs[term] resp. "problem:"/"solution:", "old:"/"new:" and "thesis:" is an addition from the Dictionary of Arguments. If a German edition is specified, the page numbers refer to this edition. |
Congressional Research Service (CRS) CRS I Congressional Research Service (CRS) Marc Labonte Fixed Exchange Rates and Floating Exchange Rates: What Have We Learned? Washington: Congressional Research Service of the Library of Congress 2007 CRS II Congressional Research Service (CRS) Paul Tierno Marc Labonte, Banking and Cryptocurrency: Policy Issues. CRS Congressional research Service Report R48430. Washington, DC. 2025 CRS III Congressional Research Service (CRS) Corrie E. Clark Heather L. Greenley, Bitcoin, Blockchain, and the Energy Sector. Washington, DC. 2019 CRS IV Congressional Reserch Service (CRS) Paul Tierno Cryptocurrency: Selected Policy Issues Congressional Reserch Service CRS Report R47425 Washington, DC. 2023 |
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