Question

What does it mean to say that a currency appreciates? Depreciates? Becomes stronger? Becomes weaker?

Short answer

Currency appreciation refers to the increase in value of one currency compared to another, while depreciation is the decrease in value. A stronger currency has more purchasing power, allowing for the purchase of more goods and services from other countries, whereas a weaker currency has less purchasing power and reduces the ability to buy goods and services. For example, if the USD/EUR exchange rate changes from \(1 USD = 0.85 EUR\) to \(1 USD = 0.90 EUR\), the USD has appreciated and become stronger, while if it changes to \(1 USD = 0.80 EUR\), the USD has depreciated and become weaker.

Step-by-step solution

1. Currency Appreciation

Currency appreciation means that the value of a currency is increasing compared to another currency. In other words, it takes more units of the foreign currency to buy one unit of the domestic currency. This means that the domestic currency can buy more of the foreign currency than before, allowing for the purchase of more goods and services from the other country. For example, if the exchange rate between the US Dollar (USD) and Euro (EUR) changes from \(1 USD = 0.85 EUR\) to \(1 USD = 0.90 EUR\), the USD has appreciated against the EUR.

2. Currency Depreciation

Currency depreciation means that the value of a currency is decreasing compared to another currency. In other words, it takes less units of the foreign currency to buy one unit of the domestic currency. This means that the domestic currency can buy less of the foreign currency than before, reducing the purchasing power in the country with the depreciated currency. For example, if the exchange rate between the US Dollar (USD) and Euro (EUR) changes from \(1 USD = 0.85 EUR\) to \(1 USD = 0.80 EUR\), the USD has depreciated against the EUR.

3. Currency Becoming Stronger

A currency becomes stronger when its value increases in relation to other currencies. A stronger currency has more purchasing power, which allows for individuals and businesses to buy more goods and services from other countries at a lower cost. This can also mean more expensive exports and cheaper imports, which can affect trade balances. In the example given in the currency appreciation step, the USD has become stronger against the EUR, as it can now purchase more with the same amount of USD.

4. Currency Becoming Weaker

A currency becomes weaker when its value decreases in relation to other currencies. A weaker currency has less purchasing power, which means individuals and businesses can buy less goods and services from other countries at a higher cost. This can also mean cheaper exports and more expensive imports, which can affect trade balances. In the example given in the currency depreciation step, the USD has become weaker against the EUR, as it can now purchase less with the same amount of USD.