Balance of Payments

Balance of payments (BOP) accounts are an accounting record of all monetary transactions between a country and the rest of the world.

Learning Objective

Define the balance of payments (BOP) account

Key Points

Balance of payments (BOP) accounts are an accounting record of all monetary transactions between a country and the rest of the world.
Sources of funds for a nation, such as exports or the receipts of loans and investments, are recorded as positive or surplus items.
Uses of funds, such as for imports or to invest in foreign countries, are recorded as negative or deficit items.
When all components of the BOP accounts are included they must equal zero with no overall surplus or deficit.

Terms

Capital Account
In macroeconomics and international finance, the capital account (also known as financial account) is one of two primary components of the balance of payments, the other being the current account. Whereas the current account reflects a nation's net income, the capital account reflects net change in national ownership of assets.
Current Account
In economics, the current account is one of the two primary components of the balance of payments (the other being the capital account). It is the sum of the balance of trade (i.e., net revenue on exports minus payments for imports), times income (earnings on foreign investments minus payments made to foreign investors), and cash transfers.
balance of payments
an accounting record of all monetary transactions between a country and the rest of the world

Example

Suppose in 2009 that (a) America exports $3 billion worth of goods (that money comes into the US when the goods are sold); (b) Saudi Arabia donates $1 billion to U.S. colleges in aid; (c) Iraq pays $500 million in interest payments for loans taken out from banks in the U.S.; (d) Chinese investors purchase $1 billion in U.S. Treasury bonds. All the activities listed above are sources of foreign exchange because foreigners are paying the U.S. so the total would be $4.5 billion. Also in 2009: (a) America imports $1.5 billion worth of goods from other countries; (b) It donates $2 billion for flood relief in Bangladesh; (c) McDonald's makes $250 million dividend payments to German shareholders; (d) General Motors spends $250 million on a new plant in China. In all these cases, money is flowing out of the U.S. and we are losing its foreign exchange because the payments have to be made in foreign currency. So in 2009, $4 billion has flown out of the U.S. If we subtract the amount of money coming in and the money going out, the surplus would be $1.5 billion. It has to be kept in mind that the balance of payments accounts have different categories for these transactions called the Current Account and Financial Account.

Full Text

Balance of Payments

Balance of payments (BOP) accounts are an accounting record of all monetary transactions between a country and the rest of the world. These transactions include payments for the country's exports and imports of goods, services, financial capital, and financial transfers. The BOP accounts summarize international transactions for a specific period, usually a year, and are prepared in a single currency, typically the domestic currency for the country concerned. Sources of funds for a nation, such as exports or the receipts of loans and investments, are recorded as positive or surplus items. Uses of funds, such as for imports or to invest in foreign countries, are recorded as negative or deficit items.

When all components of the BOP accounts are included, they must sum to zero with no overall surplus or deficit. For example, if a country is importing more than it exports, its trade balance will be in deficit, but the shortfall will have to be counter-balanced in other ways – such as by funds earned from its foreign investments, by running down central bank reserves, or by receiving loans from other countries.

While the overall BOP accounts will always balance when all types of payments are included, imbalances are possible on individual elements of the BOP, such as the current account, the capital account excluding the central bank's reserve account, or the sum of the two. Imbalances in the latter sum can result in surplus countries accumulating wealth, while deficit nations become increasingly indebted.

The term balance of payments often refers to this example: a country's balance of payments is said to be in surplus (balance of payments is positive) by a certain amount if sources of funds (such as export goods sold and bonds sold) exceed uses of funds (such as paying for imported goods and paying for foreign bonds purchased) by that amount. There is said to be a balance of payments deficit (the balance of payments is said to be negative) if the former are less than the latter.

Under a fixed exchange rate system, the central bank accommodates those flows by buying up any net inflow of funds into the country or by providing foreign currency funds to the foreign exchange market to match any international outflow of funds, thus preventing the funds flows from affecting the exchange rate between the country's currency and other currencies. Then the net change per year in the central bank's foreign exchange reserves is sometimes called the balance of payments surplus or deficit.

Alternatives to a fixed exchange rate system include a managed float where some changes of exchange rates are allowed, or at the other extreme a purely floating exchange rate (also known as a purely flexible exchange rate). The central bank does not intervene with a pure float to protect or devalue its currency, it allows the rate to be set by the market. The central bank's foreign exchange reserves do not change.

Current Account Balance, 2006

Current Account balance, 2006, U.S. dollars, per capita

[ edit ]

Prev Concept

Balance of Trade

Licensing

Next Concept