What is devaluation?

"Devaluation" is the official reduction in the value of a currency relative to one or more other currencies. This reduction is not based on free market forces, but results from a policy measure by the central bank. In the past, under the gold standard, this also meant a devaluation against gold.

Devaluation makes the domestic currency cheaper compared to other currencies, which has two important consequences: the country's exports become relatively cheaper for foreign countries, while foreign products become more expensive for domestic consumers, which discourages imports. As a result, devaluation can contribute to increasing exports, reducing imports, and reducing a current account deficit.

At the same time, devaluation can increase the prices of imported goods, which can fuel inflation. This can ultimately lead to a wage-price spiral, negating the positive effects of the devaluation. Devaluation is sometimes used as part of broader economic shock therapy to stabilize or stimulate an economy.