Which one of the following statements is the most accurate?
A) Depreciation is a rise in E when the exchange rate is fixed while devaluation is a rise in E when the exchange rate floats.
B) Depreciation is a decrease in E when the exchange rate floats while devaluation is a rise in E when the exchange rate is fixed.
C) Depreciation is a rise in E when the exchange rate floats while devaluation is a rise in E when the exchange rate is fixed.
D) Depreciation is a rise in E when the exchange rate floats while devaluation is a decrease in E when the exchange rate is fixed.
E) Depreciation is a fall in E when the exchange rate is fixed while devaluation is a fall in E when the exchange rate floats.

Question

Quizplus · Accepted Answer

Depreciation refers to a decrease in the value of a currency in the foreign exchange market relative to other currencies, while devaluation refers to a deliberate decrease in the value of a currency by the monetary authorities. Under a fixed exchange rate system, the value of the currency is fixed by the central bank, and any rise in the exchange rate is due to an increase in demand for the currency. Therefore, a rise in E (the exchange rate) under a fixed exchange rate system would be due to devaluation, which is a deliberate policy action. Under a floating exchange rate system, the value of the currency is determined by market forces of supply and demand, and a rise in E would be due to depreciation, which reflects the relative strength of the domestic and foreign currencies. Therefore, the statement that best reflects the definitions of depreciation and devaluation is that depreciation is a rise in E when the exchange rate floats while devaluation is a rise in E when the exchange rate is fixed.

Which One of the Following Statements Is the Most Accurate