When a country’s currency declines in value, it makes their goods and services cheaper for foreign buyers. This is often a part of a strategy to boost exports, reduce sovereign debt burdens, or promote economic growth. However, this also creates the risk of high inflation and massive layoffs.
Devaluation is the deliberate reduction in the value of a country’s domestic currency relative to the currencies of other countries. A country can devalue its currency in a variety of ways, such as cutting interest rates, altering reserve requirements, or directly intervening in the foreign exchange market to influence its value.
In the short run, a devalued currency will make a nation’s exports more competitive in global markets and reduce its deficit with trading partners. As a result, the country will see a boom in its terms of trade (exports minus imports). This is a common strategy for developing nations struggling to maintain a balance with the world economy.
However, it may lead to other countries devaluing their own currencies in response, leading to a tit-for-tat currency war that can damage confidence and slow trade growth. It can also lead to massive unemployment as companies are forced to cut wages or lay off workers in order to remain profitable and competitive.
A currency devaluation also tends to make it more expensive for the nation’s residents to travel abroad, reducing tourism and remittances. In a country that relies heavily on these two income sources, this could be very detrimental to the nation’s economy.
