Exchange Rates: Revaluation vs. Devaluation of a Fixed Exchange Rate

This section details the differences between revaluation and devaluation when a country operates under a fixed exchange rate regime. Understanding these concepts is crucial for analyzing the impact of policy decisions on a nation's economy.

Fixed Exchange Rate Regime

In a fixed exchange rate system, the value of a country's currency is pegged to another currency or a basket of currencies. The central bank actively intervenes in the foreign exchange market to maintain this fixed value.

Revaluation

Definition

A revaluation occurs when the value of a currency is increased in relation to the currency it is fixed to. This means the currency becomes more expensive.

Mechanism

To revalue, the central bank will buy its own currency using its foreign reserves (typically US dollars). This increased demand for the domestic currency pushes its value up.

Impacts of Revaluation

• Exports become more expensive: This can lead to a decrease in export demand.
• Imports become cheaper: This can lead to an increase in import demand.
• Trade Balance: A revaluation can worsen the trade balance (more imports, fewer exports).
• Inflation: A revaluation can help to reduce inflation by making imports cheaper.
• Economic Growth: The impact on economic growth is often debated. While cheaper imports can boost consumption, higher export prices can hinder growth.

Example

Suppose the UK has a fixed exchange rate with the Euro. If the Bank of England decides to revalue the pound, it will buy pounds using Euros. This will increase the value of the pound against the euro.

Devaluation

Definition

A devaluation occurs when the value of a currency is decreased in relation to the currency it is fixed to. This means the currency becomes cheaper.

Mechanism

To devalue, the central bank will sell its own currency in the foreign exchange market. This increased supply of the domestic currency pushes its value down.

Impacts of Devaluation

• Exports become cheaper: This can lead to an increase in export demand.
• Imports become more expensive: This can lead to a decrease in import demand.
• Trade Balance: A devaluation can improve the trade balance (more exports, fewer imports).
• Inflation: A devaluation can lead to higher inflation, as imports become more expensive.
• Economic Growth: Devaluation is often intended to boost economic growth by making exports more competitive.

Example

Suppose Argentina has a fixed exchange rate with the US Dollar. If the Central Bank of Argentina decides to devalue the peso, it will sell pesos and buy dollars. This will decrease the value of the peso against the dollar.

Comparison Table

Feature	Revaluation	Devaluation
Currency Value	Increases	Decreases
Central Bank Action	Buys own currency	Sells own currency
Exports	More expensive	Cheaper
Imports	Cheaper	More expensive
Trade Balance	Worsens	Improves
Inflation	Helps reduce	Can increase
Economic Growth	Mixed impact, often negative	Often intended to boost

Suggested diagram: A simple graph showing the exchange rate line shifting upwards for revaluation and downwards for devaluation. The graph should also indicate the impact on exports and imports.