Which of the following is / are the effects of devaluation or depreciation of currency?
1. It leads to increase in imports and decrease in exports.
2. It leads to increase in exports and decrease in imports.
3. It leads to increase in domestic inflation.
4. It leads to decrease in domestic inflation.

Select the correct answer using the code given below:

Question

Question

This question was previously asked in

CDS General Knowledge 3 Sep 2023 Official Paper

Answer 1

The correct answer is 2 and 3 only.

Key Points

Devaluation can contribute to domestic inflation because it makes imports more expensive.
- As the cost of imported goods rises, it can lead to higher overall price levels in the domestic economy.
- Devaluation occurs when a government seeks to increase its trade balance by reducing the relative value of its currency.
- The government does this by adjusting a fixed or semi-fixed exchange rate of its currency versus the exchange rate of another country's currency.
The effects of devaluation or depreciation of currency include:
- It leads to an increase in exports and a decrease in imports.
- When a currency is devalued, its exchange rate decreases relative to other currencies.
  - This makes the country's exports cheaper for foreign buyers and imports more expensive for domestic consumers, thereby promoting exports and discouraging imports.
- It leads to an increase in domestic inflation.