hello friends;

can anyone in simple way explain how curreny devalues?? and why? and what are its effects?

Thanks

Dear friend,
Devaluation is derivative of de-value. Devaluation is done by central bank (State Bank of Pakistan in our case). I tell you with example of rupee and dollar. Now a days, 87 rupees = 1 dollar, suppose. If SBP devalues rupee, it announces that now 90 rupees = 1 dollar. In this way, the surrency is devalued, or in other words value of one currency (rupee in above example) has declined in terms of another currency (dollar in above case).

This devaluation is done to earn the after-effects of it. It is mostly done in the developing countries.

Developing countries export mostly primary goods for which there is greater competition in the international markets. Suppose we are producing some export good A in Pakistan with a price Rs.3. The American importer could buy 29 units of that good with 1 Dollar before devaluation of Pakistani Rupee and 30 units after devaluation of Pakistani Rupee. So he finds our product more economical and imports from Pakistan to America more and more. Thus our exports rise.
Secondly, if we were importing something of 1 dollar from US, it meant we were paying 87 rupees before devaluation. But after devaluation, same 1 Dollar product costs us 90 rupees. So, in this way our imports are discouraged.

In this way, a country devalues its currency to encourage exports and discourage imports.

Do ask anything else regarding this if its not clear yet.

Regards,
Imran Saifi.

__________________
“Those who danced were thought to be quite insane by those who could not hear the music.”

so, from this it means devaluation is good and its done by the government deliberately.
why do we see then so often in pakistan people complain and lament the fall in the value of rupee?

It surely must have some adverse impacts..

i mean what relation does devaluation have with inflation??? isnt it true that devaluation leads to inflation or is it the other way around?

__________________
Why not !?

Yes, good question.
Actually the process is not so simple as I told you earlier. The above mentioned situation is an ideal one and for almost always it never happens so simply.
Practically speaking, devaluation can increase inflation in three ways as following;
A devaluation could cause inflation for 3 reasons.

Firstly, there is likely to be an increase in AD. As AD = C+I+G+X-M, if exports are cheaper, there will be more exports sold and the quantity of imports will fall. If the economy is close to full capacity (i.e. full employment level), then higher AD will cause inflation.

However, increased AD may not cause inflation, it depends on various factors:
a) If the economy is in recession and there is spare capacity (i.e. unemployment), a rise in AD will not cause inflation.
b) If other components of AD are not increasing (e.g. consumer spending is low), then there is unlikely to be demand pull inflation. (X-M is not the biggest component of AD).
c) Also if exports are cheaper, then the effect on AD depends upon the elasticity of demand. If demand is inelastic, there will only be a small increase in Quantity and there could be a fall in the value of exports.

Secondly, if there is a devaluation, then there will be an increase in the price of imported goods. Imports are quite a significant part of the RPI (Retail Price Index), therefore there will be cost push inflation. However, it is possible that retailers may not pass the price increases onto consumers but have lower profit margins.

Thirdly, if there is a devaluation, exports become less competitive without firms having to make much efforts, therefore there is less incentive for them to cut costs and therefore in the long run costs will increase and therefore inflation will increase. However this may not occur if firms are well run and they keep incentives to cut costs.

(See the following example of the UK.
The UK devalued its currency quite significantly in 1992 when it left the ERM, however it didn’t cause inflation. This was because the economy was in a recession and there was a lot of spare capacity. This shows there are many other factors affecting inflation. However, in the 1950 and 1960s inflation in the UK was often blamed upon the depreciating £.)

Hope I make it clear now. You can ask as many times and as many questions as you need to clear the concept. I welcome you always.

Regards,
Imran Saifi.

__________________
“Those who danced were thought to be quite insane by those who could not hear the music.”

Thanks, greatly appreciate it.

But, for a layman like me in the field of economics some terms were hard to swallow.

especially AD and C , I , G, X, M........What do they stand for?


Thanks

__________________
Why not !?

Oh sorry dear folk, I forgot to mention those abbreviations;
AD; Aggregate demand
C; Consumption
I; investment
G; government expenditures
X; exports
M; imports

Aggregate demand is a sum of consumption, investment, government expenditures, and (exports minus imports)

Feel free to ask anything about economics dear fellows, I shall do my best to make you people understand the concepts.

Regards,
Imran Saifi.

__________________
“Those who danced were thought to be quite insane by those who could not hear the music.”

Your concept will be very clear if you understand the difference between "currency devaluation" and "currency depreciation".

Here you are confusing both the terms. Try to differentiate these and then understand the implications of these.

Simply economics told that currency will be devalue when state bank print more notes & government borrow them from it. It will create inflation & when exports short fall than import the devaluation further aggregates this "viscous circle".

__________________
A contented mind is the greatest blessing a man can enjoy in this world

Currency Devaluation and Revaluation


Under a fixed exchange rate system, devaluation and revaluation are official changes in the value of a country's currency relative to other currencies. Under a floating exchange rate system, market forces generate changes in the value of the currency, known as currency depreciation or appreciation.
In a fixed exchange rate system, both devaluation and revaluation can be conducted by policymakers, usually motivated by market pressures.
The charter of the International Monetary Fund (IMF) directs policymakers to avoid "manipulating exchange rates...to gain an unfair competitive advantage over other members."
At the Bretton Woods Conference in July 1944, international leaders sought to insure a stable post-war international economic environment by creating a fixed exchange rate system. The United States played a leading role in the new arrangement, with the value of other currencies fixed in relation to the dollar and the value of the dollar fixed in terms of gold—$35 an ounce. Following the Bretton Woods agreement, the United States authorities took actions to hold down the growth of foreign central bank dollar reserves to reduce the pressure for conversion of official dollar holdings into gold.

During the mid- to late-1960s, the United States experienced a period of rising inflation. Because currencies could not fluctuate to reflect the shift in relative macroeconomic conditions between the United States and other nations, the system of fixed exchange rates came under pressure.

In 1973, the United States officially ended its adherence to the gold standard. Many other industrialized nations also switched from a system of fixed exchange rates to a system of floating rates. Since 1973, exchange rates for most industrialized countries have floated, or fluctuated, according to the supply of and demand for different currencies in international markets. An increase in the value of a currency is known as appreciation, and a decrease as depreciation. Some countries and some groups of countries, however, continue to use fixed exchange rates to help to achieve economic goals, such as price stability.

Under a fixed exchange rate system, only a decision by a country's government or monetary authority can alter the official value of the currency. Governments do, occasionally, take such measures, often in response to unusual market pressures. Devaluation, the deliberate downward adjustment in the official exchange rate, reduces the currency's value; in contrast, a revaluation is an upward change in the currency's value.

For example, suppose a government has set 10 units of its currency equal to one dollar. To devalue, it might announce that from now on 20 of its currency units will be equal to one dollar. This would make its currency half as expensive to Americans, and the U.S. dollar twice as expensive in the devaluing country. To revalue, the government might change the rate from 10 units to one dollar to five units to one dollar; this would make the currency twice as expensive to Americans, and the dollar half as costly at home.

Under What Circumstances Might a Country Devalue?
When a government devalues its currency, it is often because the interaction of market forces and policy decisions has made the currency's fixed exchange rate untenable. In order to sustain a fixed exchange rate, a country must have sufficient foreign exchange reserves, often dollars, and be willing to spend them, to purchase all offers of its currency at the established exchange rate. When a country is unable or unwilling to do so, then it must devalue its currency to a level that it is able and willing to support with its foreign exchange reserves.

A key effect of devaluation is that it makes the domestic currency cheaper relative to other currencies. There are two implications of a devaluation. First, devaluation makes the country's exports relatively less expensive for foreigners. Second, the devaluation makes foreign products relatively more expensive for domestic consumers, thus discouraging imports. This may help to increase the country's exports and decrease imports, and may therefore help to reduce the current account deficit.

There are other policy issues that might lead a country to change its fixed exchange rate. For example, rather than implementing unpopular fiscal spending policies, a government might try to use devaluation to boost aggregate demand in the economy in an effort to fight unemployment. Revaluation, which makes a currency more expensive, might be undertaken in an effort to reduce a current account surplus, where exports exceed imports, or to attempt to contain inflationary pressures.

Effects of Devaluation
A significant danger is that by increasing the price of imports and stimulating greater demand for domestic products, devaluation can aggravate inflation. If this happens, the government may have to raise interest rates to control inflation, but at the cost of slower economic growth.

Another risk of devaluation is psychological. To the extent that devaluation is viewed as a sign of economic weakness, the creditworthiness of the nation may be jeopardized. Thus, devaluation may dampen investor confidence in the country's economy and hurt the country's ability to secure foreign investment.

Another possible consequence is a round of successive devaluations. For instance, trading partners may become concerned that a devaluation might negatively affect their own export industries. Neighboring countries might devalue their own currencies to offset the effects of their trading partner's devaluation. Such "beggar thy neighbor" policies tend to exacerbate economic difficulties by creating instability in broader financial markets.

Since the 1930s, various international organizations such as the International Monetary Fund (IMF) have been established to help nations coordinate their trade and foreign exchange policies and thereby avoid successive rounds of devaluation and retaliation. The 1976 revision of Article IV of the IMF charter encourages policymakers to avoid "manipulating exchange rates...to gain an unfair competitive advantage over other members." With this revision, the IMF also set forth each member nation's right to freely choose an exchange rate system.

August 1999

Linked:http://www.newyorkfed.org/aboutthefe...int/fed38.html

__________________
One has to remember that every failure can be a stepping stone towards something better.

In Pakistan we are no more following a fixed exchange rate parity. Currency rates are purely determined on the basis of demand and supply of foreign currencies, especially dollar. This is called rupee depreciation. Pakistan is an import driven economy with significant reliance on oil. To stabilize the currency you need to earn dollars, otherwise rupee will depreciate against other currencies because for imports you have to pay in dollars that in turn increases the demand for dollar and the rupee weakens.

Coming to why people criticize it. There are many reasons for it. But the most important one is that in an import driven economy, as I mentioned earlier, rupee depreciation will only lead to inflation and less value for money. People will start holding foreign currencies that will again create demand for them in the open market and further depreciation will occur. Rupee devaluation can only be beneficial in the short term for countries like Pakistan. It has serious implications in the long run.