Question

In recent news there was a discussion about the possibility that some European Union members were considering a strategy of intentionally devaluing their currency against the dollar in order to increase exports. Explain how it is possible for a country to intentionally devalue its’ currency and then define the benefits and consequences of this strategy.

Answer 1

Devaluation of the currency can be done intentionally, by increasing the supply of domestic currency in the market. It can be done by printing new domestic currencies in the market and floating it in the market. So, it increases the supply of money and value of currency in terms of its purchasing power decreases. It makes exchange value of domestic currency w.r.t. foreign currencies decrease and export becomes cheaper. As a result, export from the country doing devaluation, increases.

The benefits are the increase in exports, increase in investment and consumption spending, leading to increase in AD and new jobs to be created in the economy. Though there are some consequences as well. The first consequence is inflationary pressure in the economy and price level increases in the economy. It is not good for the health of economy. The second consequence is worsening trade deficit situation, where imports become more expensive and domestic imports have to pay more to buy the same amount of goods. The third consequence is the reduction in the value of real wage, though nominal wage remains same. It makes workers to be at a disadvantageous position as goods become expensive and purchasing power of money decreases.