What is devaluation? Economic concepts often feel distant from our daily lives. Devaluation is one such term. When it appears in newspaper headlines or on the news, it often provokes concern. Yet devaluation is not merely a technical issue related to exchange rate policies it directly affects inflation, foreign trade balance, imports, exports, and consumer prices.
In this article, we will define devaluation and explore its causes, effects, and real-world examples from both Turkey and around the world. Because exchange rates, monetary policy, and financial stability are not just the concerns of economists they affect us all.
Definition of Devaluation: A Basic Overview and Its Place in Economics
Devaluation refers to the decline in a country’s currency value relative to other currencies. It usually occurs in economies operating under a fixed exchange rate system, where the government officially reduces the value of its national currency. However, even under floating exchange rate regimes, a rapid and sharp decline in the value of the local currency due to market forces can also be referred to as devaluation, as the consequences are often similar.
The Essence of Devaluation: The Loss of National Currency Value
In simplest terms, devaluation means getting less foreign currency in exchange for your own. For example, if 1 USD was worth 10 Turkish Lira and, after devaluation, it becomes worth 20 TL, then the lira has lost value against the dollar.
This situation directly affects purchasing power, both domestically and internationally. You begin to feel that your money doesn’t go as far, especially when buying imported goods and services.
The Relationship Between Exchange Rates and Devaluation
The exchange rate is the price of one currency in terms of another. Devaluation means that this price changes to the disadvantage of the local currency, i.e., foreign currencies become more expensive in local terms.
This shift influences:
Costs of international trade,
The burden of external debt,
Affordability of foreign travel.
In floating exchange rate regimes, devaluation may be described instead as “currency depreciation” or “weakening of the national currency,” but the effects are largely the same.
Devaluation, Inflation, and Purchasing Power: An Initial Equation
Devaluation is often mentioned alongside inflation and sometimes confused with it. Inflation is the general rise in prices over time, reflecting a decline in the purchasing power of money. Devaluation, on the other hand, is the decline in the value of a currency relative to others.
However, the two are closely interconnected:
Devaluation increases the cost of imported goods, driving inflation.
High inflation can erode trust in the economy, leading to capital flight and further currency depreciation.
In both cases, the end result is the same: the erosion of consumers' purchasing power.
The Complex Relationship Between Devaluation and Inflation: Two Sides of the Same Coin?
The connection between devaluation and inflation is not a simple cause-and-effect relationship—it’s more like a complex feedback loop.
When a currency loses value:
The cost of imported inputs and consumer goods rises.
Energy (oil, natural gas), intermediate goods, and imported food products become more expensive in local currency.
Producers pass these increased costs onto consumers, driving inflation—a phenomenon known as imported inflation.
Conversely, high and uncontrolled inflation can also trigger devaluation:
Inflation reduces trust in a country’s economic stability.
Investors and citizens turn to foreign currencies to protect their wealth.
This increased demand for foreign currency further weakens the local currency.
In short:
Devaluation can fuel inflation,
Inflation can accelerate devaluation,
A vicious cycle may develop.
That’s why maintaining macroeconomic stability by controlling both inflation and exchange rate volatility is of critical importance for any economy.