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Question

Difficulty: MediumForeign Exchange Market, Systems, and Exchange Rate Determination

Under a fixed exchange rate regime, when the central bank officially lowers the value of the domestic currency relative to foreign currencies to address persistent trade imbalances, this deliberate policy action is referred to as which of the following?

  1. DevaluationAnswer
  2. B
    Depreciation
  3. C
    Revaluation
  4. D
    Deflation

Answer

Devaluation
Devaluation describes an official policy decree by a government or central bank to lower the pegged par value of its national currency against foreign currencies under a fixed exchange rate system. This strategy aims to make domestic goods cheaper for foreign buyers and foreign goods more expensive for domestic buyers, improving the balance of trade.

Step-by-Step Solution

1
Identify the exchange rate system in operation.
The country operates under a fixed exchange rate system managed by the monetary authority.
Knowing the system determines whether currency value shifts are administrative or market-based.
2
Determine the nature and direction of the change.
The change is a deliberate downward adjustment of currency parity by the central bank.
An official government reduction of currency parity under a pegged regime is defined as devaluation.

Key Concept

Devaluation vs Depreciation in Exchange Rate Determination
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Topics

Foreign Exchange Market, Systems, and Exchange Rate Determination

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