Effects of Devaluation

Currency devaluation primarily affects a nation's trade balance, which is the difference between the value of its exports and that of its imports. Devaluation reduces the value of a nation's currency in terms of other currencies; thus, following a devaluation, a nation will have to exchange more of its own currency in order to obtain a given amount of foreign currency.


This causes the price of imports to rise and makes domestic products more attractive to consumers at home. Because it takes less foreign currency to buy a given amount of a devalued currency, the price of the nation's exports declines, making them more desirable to foreign consumers.

Depending on consumer and producer responsiveness to price changes (known as supply and demand elasticities), an effective devaluation should reduce a nation's imports and raise world demand for its exports. Improvement in a country's balance of trade will cause an increase in the new inflow of foreign currency; this, in turn, may help strengthen a country's overall balance of payments account.

The total effect of a currency devaluation depends on the actual elasticities of the supply and demand for traded goods. The more elastic the demand for imports and exports, the greater the effect of the devaluation will be on the country's trade deficits and, therefore, on its balance of payments; the less elastic the demand, the greater the necessary devaluation will be to eliminate a given imbalance.

Devaluation often is criticized as an inflationary monetary policy because it raises the domestic price of imports. The underlying cause of inflation is not devaluation, however, but rather excess money creation. Nonetheless, devaluation is an unpopular policy, especially in small countries that are extremely dependent on imports as a source of food and other necessities.