Distinguish between elasticity and absorption approach to devaluation
Answers
In a country having a stable or pegged exchange rate, the removal of balance of payments deficit can be possible through a deliberate policy measure of devaluation. The devaluation of a currency means the deliberate lowering down of the external value of a unit of home currency expressed in terms of gold, SDR’s or a foreign currency by an official edict.
Devaluation is distinct from exchange depreciation in that the latter involves the reduction in the exchange value of home currency on account of the free working of market forces. Devaluation, on the contrary, is the result of deliberate government decision for the achievement of balance of payments equilibrium.
The absorption approach is relevant to the elasticity approach. ... A devaluation is more likely to succeed when elasticities of demand for imports and exports are high and when it is accompanied by measures such as fiscal and monetary restraint that boost income relative to domestic absorption.
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