The Fixed Exchange Rate System

[Tobi]

Devaluation refers to a downward adjustment in the official exchange rate of a currency, while revaluation refers to an upward adjustment in the exchange rate. In order to understand why they occur, one first needs to get an idea of the fixed exchange rate concept.

In a fixed exchange rate system, a nation’s domestic currency is fixed to a single major currency such as the U.S. dollar or euro, or is pegged to a basket of currencies. The initial exchange rate is set at a certain level and may be allowed to fluctuate within a certain band, generally a fixed percentage either side of the base rate. The frequency of changes in the fixed exchange rate depends on the nation’s philosophy. Some nations hold the same rate for years, while others may adjust it occasionally to reflect economic fundamentals.

 

[kit_hung]

Devaluation is when a currency is officially devalued and revaluation is when it is increased. To understand this better, you must know the fixed exchange rate system, which means that a country pegs its currency to the dollar or euro or even a basket of other currencies and the price is set at a certain level and is allowed to fluctuate only slightly.

It's like the story of Atlas who carried the world without breathing. Some countries hold the same rate for years without changing it. Others change it regularly depending on the economic situation. When they see that things have changed, they calculate and adjust the rate so that the currency does not remain weak or rise too much.