Can devaluation lead to inflation? If yes, how?

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pohnpei397 | College Teacher | (Level 3) Distinguished Educator

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It is possible for devaluation to lead to inflation.  It will not necessarily happen, but it is possible.  Here are some ways in which devaluation can lead to inflation.

First, it is possible that devaluation will cause imports to decrease and exports to increase.  This happens because imports become more expensive while exports become cheaper (for foreign buyers).  This leads to an increase in aggregate demand.  If the economy is near to its full capacity, this will cause inflation because the aggregate demand curve will move right and the aggregate supply curve will be sloping upward.

Second, it is possible that devaluation can lead to cost-push inflation (the previous paragraph describes demand-pull inflation).  Devaluation causes imports to cost more.  If imports make up a lot of what is sold in a country, this can cause prices to rise.

Finally, it is possible that devaluation will cause companies’ costs and wages to rise.  If devaluation causes exports to get a lot cheaper, companies can make a bigger profit.  They might not be as careful about keeping their costs and wages low.  This could help cause inflation.

In all three of these ways, devaluation can lead to inflation, but none of these factors will inevitably cause inflation to occur.

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