Read the following statements carefully :
Statement 1 : Depreciation of currency is an economic action undertaken by the government of a nation under the fixed exchange rate system.
Statement 2 : Under the floating exchange Rate system, authorities actively intervene in the foreign exchange market by way of maintaining foreign exchange reserves.
In the light of the given statements, choose the correct option from the following :
Read the following statements carefully :
Statement 1 : Depreciation of currency is an economic action undertaken by the government of a nation under the fixed exchange rate system.
Statement 2 : Under the floating exchange Rate system, authorities actively intervene in the foreign exchange market by way of maintaining foreign exchange reserves.
In the light of the given statements, choose the correct option from the following :
Options
Correct option: (D) Both statements 1 and 2 are false.
Both statements swap the two exchange rate systems: deliberate government-led currency reduction under a fixed system is called devaluation, not depreciation; and active market intervention using forex reserves is a feature of the fixed (or managed floating) system, not a purely floating one.
Marking Scheme
- 11 mark for selecting option (D) — objective type question, no partial credit.
Hint
Match each term precisely: devaluation and intervention/reserves go with the fixed system; depreciation and market-determination go with the floating system.
Quick Oral Answer
Devaluation is a deliberate government action under a fixed exchange rate system, while depreciation is a market-driven fall in currency value under a floating exchange rate system — the two terms and systems cannot be swapped.
Analysis & Explanation
This question tests the crucial distinction between fixed and floating exchange rate systems and their associated terminology.
Why Statement 1 is false
- Under a fixed exchange rate system, when the government deliberately reduces the official value of its currency, this action is called devaluation, not depreciation.
- Depreciation refers to a market-driven fall in currency value under a floating exchange rate system, and it is not a deliberate government action.
Why Statement 2 is false
- Under a genuine floating exchange rate system, the exchange rate is determined purely by market forces of demand and supply, with authorities not intervening.
- Active intervention using forex reserves to maintain a target rate is a feature of the fixed exchange rate system (or a managed float), not a freely floating one.
Conclusion: Since both statements interchange the defining features of the two systems, both are false, making option (D) correct.
Common Mistakes
- 1Using 'devaluation' and 'depreciation' interchangeably — devaluation is a deliberate government act under a fixed system; depreciation is a market-driven change under a floating system.
- 2Believing that intervention with forex reserves happens under a floating system, when it is actually characteristic of a fixed (or managed) exchange rate regime.
Interesting Facts
India devalued the rupee twice in quick succession in June 1966 under the fixed exchange rate regime then in place, to correct a severe balance of payments crisis.
India moved to a market-determined (floating) exchange rate system in 1993, after which the term 'depreciation' rather than 'devaluation' became applicable to rupee movements.
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Frequently Asked Questions
What is the difference between devaluation and depreciation?
Devaluation is a deliberate reduction in the official value of a currency by the government under a fixed exchange rate system. Depreciation is a market-driven fall in currency value under a floating exchange rate system, occurring automatically due to demand-supply forces without government action.
Do authorities intervene in the forex market under a floating exchange rate system?
Under a purely (freely) floating system, authorities do not intervene — the rate is fully market-determined. Active intervention using forex reserves is typical of a fixed exchange rate system or a managed float, not a free float.