The balance of payments (BOP) tracks the financial transactions made between the government, businesses, and consumers of a country with the rest of the world. The balance of payments shows how much consumers and firms are spending on imported goods and services and how many exports are going to other countries. The account of balance of payments is the accumulation of the balance of trade in goods and services and net investment incomes from net transfers and overseas assets. These accounts usually give a summary of the yearly international transactions and are presented in the domestic currency. The balance of payments account must equal to zero when all variables of BOP are included.
The two elements of the BOP account are the current account and the capital account. The current account is the net amount earned by a country if it is in surplus or deficit. It is the sum of cash transfers, factor income, and balance of trade¹. The capital account tracks the net change in ownership of foreign assets. The capital account takes the reserve account into consideration as well as international loans and investments.
The balance of payments has to equal to zero but imbalances can occur because of surpluses or deficits of individual variables. One type of deficit is a visible trade deficit, which is when a nation imports more goods than it exports¹. Another type of deficit is a basic deficit, which is when the current account includes foreign direct investments¹.
When assessing a country’s current account, one must look at changes in economic growth rates and national income. This is because it will have a strong impact on the level of imports. Changes in relative prices or inflation rates will alter the comparative prices of a nation’s imports and exports¹. A rise in inflation will cause a country to see an increase in their price of exports and a decrease in the price of imports.
1. Kaplan, Jay. (2002). Balance of Payments. Retrieved from www.colorado.edu/Economics/courses/econ2020/section12/section12-main.html