Why Currencies Rise and Fall: Difference Between Devaluation and Depreciation
- Cristabelle Chang
- 2 days ago
- 3 min read
Exchange rates move constantly, shaping the flow of trade, investment, and global competitiveness.
Yet few terms are as misunderstood: devaluation and depreciation.
Both terms describe a fall in a currency’s value, but they originate from very different mechanisms.
One is controlled by the markets and the other is controlled by policy.
The Market Mechanism: Depreciation
In economies that operate under a floating exchange rate system, currency values are determined by the interaction of supply and demand in the foreign exchange market.
When a currency depreciates, its value falls relative to another because of market forces, not government intervention.
Several factors can cause depreciation:
Falling demand for exports – When foreign buyers purchase fewer domestic goods, demand for the currency declines.
Rising imports – If consumers and firms import more, they must sell domestic currency to buy foreign currency, reducing its value.
Capital flight – Investors withdrawing funds from local markets to invest abroad create downward pressure on the currency.
Loss in Confidence – Expectations of a weaker currency often become self-fulfilling, as traders sell ahead of anticipated declines.
Example: During the early months of the COVID-19 pandemic, investors sought safety in the U.S. dollar. As capital flowed out of emerging markets, many currencies, including the Thai baht, depreciated sharply.
In summary, Depreciation is a market-driven fall in value under a floating exchange rate.
The Policy Mechanism: Devaluation
In contrast, devaluation occurs under a fixed exchange rate system, where a government or central bank sets the currency’s official value relative to another. When authorities deliberately lower that fixed value, the result is a devaluation.
Governments typically devalue their currencies to:
Increase exports – A weaker currency makes domestic goods cheaper to foreign buyers.
Reduce trade deficits – Higher import prices can discourage excessive import demand.
Stimulate growth – Lower exchange rates can support manufacturing, tourism, and employment.
Example: In 1994, China devalued the yuan by roughly 33 percent to strengthen export competitiveness and attract foreign investment. The move became a foundation for its manufacturing-driven growth in the following decades.
In summary: Devaluation is a policy-driven fall in value under a fixed exchange rate.
When Currencies Strengthen: Appreciation and Revaluation
Currencies do not only fall; they also rise. These upward movements are described by appreciation and revaluation.
Appreciation: occurs under a floating exchange rate when market demand increases. Strong capital inflows, rising exports, or higher interest rates can all cause appreciation.
Revaluation: occurs under a fixed exchange rate when the government intentionally increases the official value of its currency relative to another.
Both terms mirror depreciation and devaluation, but in the opposite direction.
Comparison at a Glance
Term | Exchange Rate System | Who Controls It | Direction of Change | Example |
Depreciation | Floating | Market forces | Value decreases | Thai baht weakens against USD |
Devaluation | Fixed | Government. or central bank | Value decreases | China lowers yuan peg |
Appreciation | Floating | Market forces | Value increases | Thai baht strengthens against USD |
Revaluation | Fixed | Government. or central bank | Value increases | Central bank raises official rate |
Why Exchange Rates Move
Exchange rates behave like prices, reflecting confidence, expectations, and economic performance. The main drivers include:
Interest rate: Higher domestic interest rates attract investors seeking better returns, strengthening the currency.
Inflation rates: Higher inflation erodes purchasing power, leading to currency weakness.
Trade balance: Countries with strong export performance often experience appreciation, while persistent trade deficits can lead to depreciation.
Speculative flows: Investor intentions and expectations can accelerate short-term movements.
Government intervention: Central banks may buy or sell reserves to manage volatility or maintain a target level.
The Economic Impact
Exchange rate movements have broad consequences for consumers, businesses, and governments.
A weaker currency (from devaluation or depreciation) generally benefits exporters and tourism by making domestic goods cheaper abroad. However, it raises the cost of imports and can trigger inflation.
Conversely, a stronger currency (from revaluation or appreciation) makes imports cheaper and can lower inflation, however negatively impact exporters and stun growth. Policymakers must balance these trade-offs carefully, as excessive fluctuations can destabilize economies.
One well-known outcome is the J-Curve effect. After a devaluation, a country’s trade balance often worsens before it improves. Import prices rise immediately, but export volumes take time to respond to the new, cheaper prices.
Conclusion
Devaluation and depreciation describe similar outcomes, a fall in a currency’s value, but stem from fundamentally different causes. Depreciation is an outcome of market behavior, while devaluation is a policy choice.
Understanding how and why currencies rise and fall offers not only insight into global finance but also a reflection of how economies manage the delicate balance between growth and stability.
Thanks for reading!– Cristabelle Chang