Currency appreciation and depreciation
Currency depreciation is the loss of value of a country's currency with respect to one or more foreign reference currencies, typically in a floating exchange rate system. It is most often used for the unofficial increase of the exchange rate due to market forces, though sometimes it appears interchangeably with devaluation. Its opposite, an increase of value of a currency, is currency appreciation.
The depreciation of a country's currency refers to a decrease in the value of that country's currency. For instance, if the Canadian dollar depreciates relative to the euro, the exchange rate (the Canadian dollar price of euros) rises: it takes more Canadian dollars to purchase 1 euro (1 EUR=1.5 CAD → 1 EUR=1.7 CAD).
When the Canadian dollar depreciates relative to the euro, Canadian goods become more competitive on world markets because their price when exchanged to euro will be lower. The result will be an increase in Canadian exports. On the other hand, European sellers that denominate their goods and services in euros will be less competitive, because European products denominated in euros will be more expensive in Canada.
The appreciation of a country's currency refers to an increase in the value of that country's currency. Continuing with the CAD/EUR example, if the Canadian dollar appreciates relative to the euro, the exchange rate falls: it takes fewer Canadian dollars to purchase 1 euro (1 EUR=1.5 CAD → 1 EUR=1.4 CAD). When the Canadian dollar appreciates relative to the Euro, the Canadian dollar becomes less competitive. This will lead to larger imports of European goods and services, and lower exports of Canadian goods and services.
How currency appreciates
A currency appreciates as a result of increased demand for that currency on world markets: its value in the world market increases. This increase in demand can occur for several reasons:
- When a country's exports are high, the buyers of these exports need its currency to pay for those exports.
- When the country's central bank increases interest rates. When employment and per capita income in a country increase, the demand for its goods and services increases, along with demand for that country's currency in the local market.
- When the demand of the currency is high in foreign exchange market
- Due to Government borrowing or loosening of fiscal policy. See Twin deficits hypothesis
- Capital appreciation (accounting and finance)
- Floating exchange rate
- Fixed exchange-rate system
- Marshall–Lerner condition
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