Balance of Payments
What is Balance of Payments?
The balance of payments is a record of all economic transactions between a country and the rest of the world over a period.
It is made up mainly of the current account (trade and income flows) and the capital and financial account (asset flows). The two broadly offset each other, so the overall balance tends toward zero. A current account deficit is mirrored by a financial account surplus.
Balance of Payments: a worked example
Suppose a country reports a trade balance of negative $140 billion, net investment income of positive $25 billion, and net transfers of negative $15 billion, so the current account is -140 + 25 - 15 = negative $130 billion. Now turn to the other side of the ledger. Foreigners buy $180 billion of domestic bonds, factories, and property, while domestic residents buy $50 billion of foreign assets, giving 180 - 50 = positive $130 billion in the capital and financial account. Add the two: -130 + 130 = 0. The country covers the $130 billion it spent abroad beyond what it earned by selling $130 billion more in assets than it bought, which is what the identity means in plain terms.
The mistake students make with balance of payments
A frequent slip is treating the current account and the capital and financial account as independent, so students answer that both could run deficits at once. The intuition feels safe, since a country importing heavily seems to be losing on every front. The two accounts are really two sides of one transaction: paying foreigners more for goods than they pay you leaves them holding your currency, which returns as purchases of your assets. When the current account deficit widens, the financial account surplus must widen by roughly the same amount.
Balance of Payments questions
What are the two main parts of the balance of payments?
The current account and the capital and financial account make up the balance of payments. The current account records trade in goods and services, net investment income, and net transfers such as remittances and foreign aid. The capital and financial account records purchases and sales of assets, including foreign direct investment, bonds, shares, and real estate. Because every payment abroad has a matching entry, the two accounts offset each other and sum to roughly zero.
How do you tell a credit from a debit in the balance of payments?
Credits record value flowing in: exports sold abroad, income received on assets held overseas, and sales of domestic assets to foreigners. Debits record value flowing out: imports purchased, income paid to foreign owners, and purchases of foreign assets by residents. A $40 billion machinery export is a credit in the current account, while a resident buying $40 billion of foreign shares is a debit in the financial account. Each transaction generates one of each, which is why the totals offset.
Is a current account deficit a sign of a weak economy?
A current account deficit means a country buys more goods, services, and income flows from abroad than it sells, financing the gap by selling assets or borrowing. Whether that signals weakness depends on what the incoming funds do. Money that finances new factories, ports, and equipment can raise future output enough to service the obligations, while money financing only current consumption leaves the obligations with no added capacity. Fast-growing economies with attractive investment opportunities often run deficits for years.
Formula / Example
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Related terms
Common comparisons
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