tutor2u | Exchange Rates - Competitive Devaluations

Study Notes

Exchange Rates - Competitive Devaluations

Level:
A Level
Board:
AQA, Edexcel, OCR, IB

Last updated 22 Mar 2021

Competitive devaluations occur when a country deliberately intervenes to drive down the value of their currency to provide a competitive boost to demand and jobs in their export industries.

Competitive Devaluations / Dirty Floats

Currency intervention on the rise

More than 20 countries have increased their aggregate foreign exchange reserves and other official foreign assets by an annual average of nearly $1 trillion in recent years.

This buildup of official assets—mainly through intervention in the foreign exchange markets—keeps the currencies of the interveners substantially undervalued, thus boosting their international competitiveness and trade surpluses.

Source: Bergston and Gagnon, Jan 2013

Motivations for a competitive devaluation of a currency

  • They may try this when faced with a deflationary recession or to attract extra foreign investment
  • For nations with persistent trade deficits and rising unemployment a competitive devaluation of the exchange rate can become an attractive option - but there are risks
  • Devaluing an exchange rate can be seen by other countries as a form of trade (or crisis) protectionism that invites some form of retaliatory action
  • Cutting the exchange rate makes it harder for other countries to export their goods and services hitting their circular flow.
The Russian rouble has been "devalued" several times against the US dollar in recent years

One of the reasons as to why the 1930s Great Depression lasted so long was that countries acted independently to protect their own interest by undermining their currencies. Ultimately a competitive devaluation provides only a temporary boost to competitiveness. A policy of holding down an exchange rate can be costly.

For many years the International Monetary Fund (IMF) has tried to help countries coordinate their trade and foreign exchange policies in order to prevent repeated devaluations. The 1976 revision of Article IV of the IMF charter was written to avoid "manipulating exchange rates...to gain an unfair competitive advantage over other members

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