Currency appreciation and depreciation
In a floating exchange rate system, a currency's value goes up (or down) if the demand for it goes up more (or less) than the supply does. In the short run this can happen unpredictably for a variety of reasons, including the balance of trade, speculation, or other factors in the international capital market. For example, a surge in purchases of foreign goods by home country residents will cause a surge in demand for foreign currency with which to pay for those goods, causing a depreciation of the home currency. Another cause of appreciation (or depreciation) of a currency is speculative movements of funds in the belief that a currency is under- (or over-)valued and in anticipation of a “correction”. Such movements may in themselves cause the value of a currency to change. A longer-run trend of appreciation (or depreciation) is likely to be caused by home country inflation being lower (or higher) on average than inflation in other countries, according to the principle of long-run purchasing power parity. When a country's currency appreciates in relation to foreign currencies, foreign goods become cheaper in the domestic market and there is overall downward pressure on domestic prices. In contrast, the prices of domestic goods paid by foreigners go up, which tends to decrease foreign demand for domestic products. A depreciation of the home currency has the opposite effects. Thus, depreciation of a currency tends to increase a country’s balance of trade (exports minus imports) by improving the competitiveness of domestic goods in foreign markets while making foreign goods less competitive in the domestic market by becoming more expensive. In the international capital market, a change in a currency’s value may give rise to a foreign exchange gain or loss. The appreciation of the domestic currency raises the value of financial instruments denominated in that currency, while there is an adverse impact on debt instruments. To predict currency appreciation and depreciation, traders use the economic calendar. The calendar includes economic releases that determine the strengths and weaknesses of the economy. Thus, if a trader only knows that the GDP growth of the country whose currency he trades declined compared with the forecast, he can expect the fall of the domestic currency. Also, the terms are used when talking about the central bank monetary policy. The central bank is a single authority that issues money. Thus, its policy has an impact on the domestic currency: if the central bank raises the interest rate, or gives optimistic comments on the country’s economy, the domestic currency appreciates. If the bank cuts the interest rate or signals problems for the economy, the domestic currency depreciates. Alterations in the value of a country's currency has distributional consequences within the country and between countries. As a consequence, currency depreciations and appreciations have political consequences. Currency appreciation benefits consumers, as it makes foreign goods cheaper, but it harms national producers who face greater competition with foreign producers. A depreciation has the opposite effect. Special interest groups subsequently lobby for increases or decreases in the currency. Governments are generally punished for currency depreciations. If a country relies on many imported goods, a currency depreciation can reduce living standards, weaken economic growth, and increase inflation. However, a depreciation can also strengthen domestic producers and increase aggregate output, making it a common policy option to facilitate economic recoveries.
Political effects
High and low values have tradeoffs, along with distributional consequences for different groups.