Discussion – Global Economics

Question 1:
Currency Devaluation
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Discuss the purpose of a currency devaluation? What about a
currency revaluation? Under what circumstances should a nation
devalue currency?
Identify a developing country that adopted currency boards?
Discuss why they chose this instead of dollarizing their monetary
systems.

Directions:
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Discuss the concepts, principles, and theories from your textbook.
Cite your textbooks and cite any other sources if appropriate.

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Your initial post should address all components of the question
with a 500 word limit.

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Reply to at least two discussion posts with comments that further
and advance the discussion topic.

Question 2: Reply to two discussion (between 70 – 150
words) for each student.
Discussion – Student 1
Currency devaluation refers to the intentional reduction in the value of a country’s currency in
relation to another currency or currencies or even comes in terms with a standard like gold.
Usually applied by a government or a central bank in a closed or partially closed exchange
rate system for the purpose of making its exports cheaper, to fund trade imbalance or to boost
economic growth. But it can also raise the price of imports and possibly set off inflation
(Mankiw, 2021).
The primary purpose is to improve a country’s competitiveness in exports and make exports
more appealing in overseas markets to help increase demand, cut trade deficits while
boosting economic growth. It can also offer short-run remedy to countries with balance of
payments difficulties or countries with large external debts measured in foreign
currencies (Krugman & Obstfeld, 2022). On the other hand, Currency revaluation, the
intentional raising of the value of the country’s currency, has diverse functions. It can

decrease inflation by cutting import expenses and enhance domestic demand as well as
responding to the sheer underestimation often provoked by globalization (Mankiw, 2021). A
country may choose to devalue its currency under situations like a current account deficits,
economic declines or crises, or balance of payment difficulties for which, improving export
credit is essential. But as with most defence instruments, devaluation, while it motivates
exports and has other short-terms benefits, raises the costs of imports and can cause inflation
if improperly handled (IMF, 2023).
One of the most famous developing nations that embraced the currency board is Hong Kong.
Hong Kong officially adopted the currency board system to link with the U.S dollar at a fixed
rate in the year 1983. A currency board is monetary system in which the value of the given
country currency depends on therelative value of the foreign currency; the note issue of
dependencies is backed by foreign currency reserves. This system ensures that every unit of
domestic currency in circulation is matched by an equivalent amount of foreign currency,
which strengthens monetary discipline (Hanke & Schuler, 2015).
Hong Kong chose a currency board over dollarization for several reasons. First, maintaining a
domestic currency under a currency board allows a country to retain its monetary sovereignty
to some extent, even though it operates within strict rules. Dollarization, on the other hand,
would mean entirely replacing the local currency with the U.S. dollar, leading to a loss of
independent monetary policy and the seigniorage revenue (the profit from issuing currency)
that accrues to the issuing authority (Frankel, 2005).
Second, the currency board offered a credible commitment to monetary stability and low
inflation, addressing public confidence issues during periods of economic uncertainty. For
Hong Kong, the currency board created a mechanism for stabilizing the financial system
during political and economic pressures, such as those experienced during negotiations over
the territory’s return to China (Hanke & Schuler, 2015).
In contrast, dollarization might have been seen as too rigid, leaving no room for adjustments
tailored to local economic conditions. By opting for a currency board, Hong Kong was able to
maintain a high degree of financial credibility while keeping its local currency and benefiting
from the flexibility of being tied to the U.S. dollar without full dependency.

Refernces:
Frankel, J. A. (2005). On the renminbi: The choice between adjustment under a fixed
exchange rate and adjustment under a flexible rate. The National Bureau of Economic
Research.
Hanke, S. H., & Schuler, K. (2015). Currency boards for developing countries: A handbook.
Center for Financial Stability.
International Monetary Fund. (2023). Exchange rate policies.
Krugman, P. R., & Obstfeld, M. (2022). International economics: Theory and policy (12th ed.).
Pearson Education.
Mankiw, N. G. (2021). Principles of economics (9th ed.). Cengage Learning.

Answer: (between 70 – 150 words)

Discussion – Student 2
Currency devaluation refers to the deliberate lowering of a country’s currency value
relative to foreign currencies. Governments or central banks may devalue their currency
for several purposes, primarily to improve the country’s trade balance. By making
exports cheaper, a devalued currency boosts the competitiveness of a nation’s goods
and services on the international market. It can also help reduce trade deficits and
stimulate economic growth, as foreign buyers may demand more exports when they
become less expensive in their own currency. Additionally, devaluation can help reduce
the real burden of external debt denominated in foreign currencies (Carbaugh, 2018).
However, currency devaluation comes with risks, such as rising import costs, which
can contribute to inflation. The increased cost of imported goods may lead to higher
prices domestically, reducing consumer purchasing power. Additionally, devaluation
can reduce investor confidence if it signals economic instability, potentially resulting
in capital outflows. Therefore, devaluation should be used judiciously, as part of a
broader strategy to address macroeconomic imbalances.

Currency revaluation, on the other hand, is the increase in the value of a country’s
currency in the foreign exchange market, often in response to rising demand for that
currency. Governments may engage in revaluation to control inflationary pressures by
reducing the cost of imports and stabilizing domestic prices. Revaluation can also
reflect a nation’s economic strength or improvement in its balance of payments position.
It can enhance investor confidence and reduce external debt burdens denominated in
foreign currencies. In general, revaluation is employed when a country experiences
excessive inflation or has a strong external position, with high levels of foreign reserves
and a surplus in its current account. However, like devaluation, revaluation carries its

risks, particularly the potential harm to export competitiveness as domestic goods
become more expensive for foreign buyers.

When Should a Nation Devalue Its Currency?

A nation should consider devaluing its currency under certain economic conditions.
Primarily, if the country is facing persistent trade deficits and a lack of competitiveness
in international markets, devaluation may be a viable tool to boost exports and reduce
the trade imbalance. Devaluation can also be considered if the country has a high level
of external debt that it wants to reduce in real terms, or if there is a need to stimulate
growth in a sluggish economy. In cases of a fixed exchange rate regime, a government
may decide to devalue the currency if its foreign reserves are insufficient to defend the
peg (Krugman & Obstfeld, 2018). Devaluation is also a potential response to
speculative attacks or a lack of confidence in the country’s monetary policies.

Developing Country Adopting Currency Boards (Argentina)

A developing country that adopted a currency board arrangement is Argentina. In
the 1990s, Argentina established a currency board system, pegging the Argentine peso
to the U.S. dollar at a 1:1 ratio. This decision was made in response to hyperinflation
and a collapsing economy during the late 1980s and early 1990s. By adopting the
currency board, Argentina hoped to gain stability, control inflation, and attract foreign
investment. A currency board requires the country to hold sufficient foreign currency
reserves to back its domestic currency in circulation, ensuring that it can always
exchange pesos for U.S. dollars at the fixed rate (Carbaugh, 2018).

Argentina chose the currency board over dollarization (i.e., adopting the U.S. dollar
as its official currency) for several reasons. First, dollarization would have meant losing
control over its monetary policy entirely, which could be detrimental during times of

economic crisis. The currency board, on the other hand, allowed the country to retain
its own currency while still anchoring it to a stable foreign currency. This system
offered more flexibility for Argentina’s government and central bank in terms of
managing financial crises, albeit with significant constraints on monetary policy.
Although the currency board initially brought stability and reduced inflation, it
ultimately faced challenges, such as the inability to respond to external shocks, leading
to Argentina’s abandonment of the system in 2002 (Cuddington, 2005).

In conclusion, currency devaluation and revaluation are tools used by governments
to address macroeconomic imbalances and manage trade and inflation dynamics.
Devaluation is typically employed when a country needs to boost exports and reduce
external debt, whereas revaluation can be used to control inflation and maintain
economic stability. In terms of monetary systems, developing countries like Argentina
have opted for currency boards to maintain control over their currency while benefiting
from the stability of foreign currency pegs, rather than fully dollarizing, which would
eliminate domestic control over monetary policy.

References

Carbaugh, R. J. (2018). International economics (18th ed.). Cengage Learning.
Cuddington, J. T. (2005). Currency boards: The case of Argentina. Journal of Economic
Development, 30(2), 57-81.
Krugman, P., & Obstfeld, M. (2018). International economics: Theory and policy (10th
ed.). Pearson.

Answer: (between 70 – 150 words)

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