Competitive devaluation

3 Key Takeaways

• Competitive devaluation aims to make a country’s exports cheaper and imports more expensive.
• It can lead to a cycle of retaliatory devaluations among countries.
• The practice is generally discouraged due to its potential negative impacts on the global economy.

What is Competitive Devaluation?

Competitive devaluation is a deliberate policy action by a country’s central bank or government to reduce the value of its currency relative to other currencies. This is typically done by selling the domestic currency and buying foreign currencies, or by lowering interest rates to discourage foreign investment. The goal is to make the country’s exports more competitive and boost economic growth.

Importance (or rather, Concerns) about Competitive Devaluation

• Short-Term Gains, Long-Term Risks: While competitive devaluation might provide a temporary boost to exports, it can lead to a cycle of retaliatory devaluations by other countries, ultimately negating any initial gains.
• Global Instability: Currency wars can destabilize the global economy, creating uncertainty for businesses and investors, and potentially leading to trade conflicts.
• Inflationary Pressures: A weaker currency can lead to higher import prices, potentially fueling inflation within the country.
• Loss of Confidence: Persistent devaluation can erode confidence in a country’s currency and economic management, making it difficult to attract foreign investment.

How Competitive Devaluation Works

1. Central Bank Intervention: The central bank intervenes in the foreign exchange market by selling its own currency and buying foreign currencies, increasing the supply of the domestic currency and decreasing its value.
2. Lowering Interest Rates: The central bank may lower interest rates to discourage foreign investment, leading to capital outflows and a weaker currency.
3. Trade Impact: The weaker currency makes exports cheaper and imports more expensive, potentially boosting export demand and reducing import demand.
4. Retaliation: Other countries may respond by devaluing their own currencies, leading to a cycle of competitive devaluation.

Examples of Competitive Devaluation

• The Great Depression: In the 1930s, many countries engaged in competitive devaluations in an attempt to gain a trade advantage during the global economic crisis.
• Recent Currency Wars: In recent years, there have been concerns about potential currency wars between major economies, as some countries have sought to weaken their currencies to stimulate exports.

Real-World Applications

While competitive devaluation might seem like an attractive policy option for boosting exports in the short term, it is a risky strategy with potentially harmful consequences for the global economy. Therefore, it is generally discouraged by international organizations like the International Monetary Fund (IMF).

It is important to note that not all currency depreciations are the result of deliberate policy actions. Some depreciations may occur due to market forces, such as changes in investor sentiment or economic fundamentals. However, when a country intentionally weakens its currency to gain a trade advantage, it raises concerns about competitive devaluation and its potential negative effects.