Currency appreciation and depreciation

William Huskisson, Question concerning the depreciation of our currency, 1810

Currency depreciation is the loss of value of a country's currency with respect to one or more foreign reference currencies, typically in a floating exchange rate system in which no official currency value is maintained.^[1] Currency appreciation in the same context is an increase in the value of the currency.

Causes

In a floating exchange rate system, a currency's value goes up (or down) if the demand for it goes up more (or less) than the supply does. In the short run this can happen unpredictably for a variety of reasons, having to do with trade flows, speculation, or other factors in the international capital market. For example, a surge in purchases of foreign goods by home country residents will cause a surge in demand for foreign currency with which to pay for those goods, causing a depreciation of the home currency.

A longer-run trend of appreciation (or depreciation) is likely to be caused by home country inflation being lower (or higher) on average than inflation in other countries, according to the principle of long-run purchasing power parity.

Effects

An appreciation of a country's currency makes it cheaper to buy foreign currency with which to pay for foreign goods, leading to more of that activity, and leading to downward pressure on the home price level as the foreign-goods component of the market basket, used for calculating the price level, becomes less expensive. In contrast, purchases of home country goods by foreigners become more expensive since the home country currency has become more expensive to obtain. This then decreases the demand on the overall elastic products. A depreciation of the home currency has the opposite effects and vice versa.

See also

References