Depreciation vs Devaluation: What’s the Difference?
Learn why a falling currency depreciates under a floating exchange rate but is devalued when authorities officially lower its fixed rate, with an example.
Depreciation and devaluation both mean a currency loses value against another currency. The difference is how it happens: depreciation is a fall in a floating exchange rate determined by the market; devaluation is an official reduction in the value of a currency under a fixed exchange rate system.
How does each happen?
A floating exchange rate changes as demand for and supply of the currency change. If demand for a currency falls, its exchange rate may fall. That fall is depreciation. It is not a government decision to set a new official rate.
Under a fixed exchange rate system, the authorities aim to maintain an official exchange rate. If they decide to lower that rate, the change is devaluation. The key distinction is therefore the exchange rate system, not the size of the fall.
A simple example
Suppose one unit of a country’s currency initially buys 1.251.251.25 units of a foreign currency and later buys 1.001.001.00. Its value has fallen. If this happened through market trading under a floating system, it depreciated. If the authorities officially lowered its fixed rate, it was devalued.
Either change can make exports cheaper to foreign buyers and imports more expensive for domestic buyers, although the effect on trade depends on how buyers respond to price changes. In an exam answer, do not describe an official change to a fixed rate as depreciation simply because the currency’s value went down. Say devaluation and identify the exchange rate system.
Syllabus focus: AS Level Exchange rates covers depreciation of a floating exchange rate at 6.4.3. A Level Exchange rates adds devaluation of a fixed exchange rate at 11.2.3.
