What are the causes of currency depreciation?

Written by sue-lynn carty | 13/05/2017
What are the causes of currency depreciation?
Inflation is one of the main culprits behind currency depreciation. (Robert Kirk/Photodisc/Getty Images)

When currency depreciates, it loses value and purchasing power. Fluctuations in currency value are a common event and are usually no cause for concern. The minor daily increases and decreases in value are generally due to investor supply and demand and not due to an economic event. Changes in currency value become significant when the depreciation of currency is an ongoing trend.

Inflationary Pressure

Inflation is one of the biggest factors in currency depreciation. When inflation occurs, the general prices of goods and services are on an upward trend. When inflation rises too rapidly, currency then depreciates. This occurs because consumers have to spend increased amounts of money on goods and services during inflationary periods than they do during non-inflationary periods. Generally, a steady rate of inflation is a positive event because it indicates economic growth.

National Trade Deficit

When the total dollar value of a country's imports exceeds the total dollar value of its exports, the county has a trade deficit. This means the country is exporting fewer goods then it is importing. When a country's trade deficit increases, the value of that country's currency depreciates against the currency of its trading partner countries. For example, if the U.S. imports more goods from Canada then it exports to Canada, then the U.S. dollar depreciates against the Canadian dollar.

Economic Money Supply

When federal governments adjust their nation's monetary policy, they are attempting to find equilibrium between the supply and demand for money. In the U.S., the Federal Open Market Committee or FOMC controls the money supply. Two common ways the FOMC increases the economic money supply is by printing new money or selling government-owned securities. When either of these two events occurs, U.S. currency depreciates because the supply of money is higher than its demand.

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