MacroeconomicsI_working_version (1)

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Chapter 14
1) European Monetary Union: Austria, Belgium, Finland, France, Germany, Greece,
Ireland, Italy, Luxembourg, Netherlands, Portugal, Spain
2) Euro-peggers (pegged to the euro): Denmark, Croatia, Hungary, Iceland
3) Managed floaters: Norway, Sweden, Czech Republic, Finland, Latvia, Macedonia,
Romania, Slovak Republic, Slovenia, Ukraine
4) Free floaters: UK, Sweden, Albania, Moldavia, Poland, Russia, Switzerland
5) Currency board: Estonia, Lithuania, Bosnia-Herzegovina, Bulgaria
Source: IMF, Burda – Wyplosz (2001)
14.3. Devaluation, Revaluation vs. Depreciation and
Appreciation
The terms devaluation, revaluation, depreciation and appreciation are very frequent in
economic literature. Using these terms could be sometimes confusing. Let’s explain the
actual meanings and differences of the terms.
A depreciation and appreciation refers to a change in the price (value) of foreign currencies
under flexible exchange rate regime. A currency depreciates when, under floating rates, it
becomes less expensive in terms of foreign currencies. It means that the international value
of the currency declines relative to another currency. Conversely, an appreciation refers to
an increase in the international value of the currency relative to another one, which is that a
currency becomes more expensive in terms of foreign currency.
A revaluation or devaluation occur when the price of a currency is increased or decreased
in terms of foreign currency under fixed rate regime by an official action. A revaluation
thus means that residents of the revaluating country pay less for foreign currencies and
foreigners pay more for the revaluated currency. A devaluation is the opposite of a
revaluation.
14.4. Exchange Rates Determinants
Let’s examine what factors determine the changes in the price of a currency – the exchange
rate. We will focus on factors causing appreciation or depreciation because the changes
under fixed exchange rate regime (devaluation and revaluation) are always caused by an
exogenous official action of government or the central bank.
• Changing consumer preferences. Changes in consumer tastes or preferences for the
products of foreign country may influence the demand for that nation’s currency and
thus its exchange rate. If, for example technological advantages in German cars will
make them more attractive to British consumers and businesses, then British will
demand more euros so that they could purchase these cars. Supply of British pounds
thus increases (the supply curve moves rightwards) and British pound depreciates. Euro
appreciates.
• Changes in national incomes. A country’s currency tends to depreciate if its national
income raises more rapidly then that of other countries’. The reason is that a rise in
imports is positively correlated with a rise in income. Thus, a country with higher
growth in income will demand more foreign goods relative to a country with lower
income growth. Households and businesses in expanding country will demand more