What is Devaluation?
Devaluation refers to a decrease in a's value with respect to other currencies.
How Does Devaluation Work?
A central bank can make the conscious effort to make its less valuable. If Country XYZ's is set at a fixed exchange rate of 2:1 to the U.S. dollar and, due to a weak economy, XYZ cannot afford to pay the interest rate on its debt outstanding, XYZ may devalue their . This means the central bank of XYZ will declare their fixed exchange rate to be 10:1 to the U.S. dollar. This makes their debt outstanding is now worth five times less. It's a very tricky maneuver with grave economic consequences.
Why Does Devaluation Matter?
Whether deliberate or as a result of market climate, devaluation reduces the price of a country's domestic output. This has the potential to benefit the economy by helping to increase its export volume. Conversely, import volumes become stifled as the price of foreign-produced goods and services increases dramatically.
The opposite of devaluation is known as revaluation.