BALANCE OF PAYMENTS: A comprehensive set of accounts that tracks the flow of currency and other monetary assets coming in to and going out of a nation. These payments are used for international trade, foreign investments, and other financial activities. The balance of payments is divided into two accounts -- current account (which includes payments for imports, exports, services, and transfers) and capital account (which includes payments for physical and financial assets). A deficit in one account is matched by a surplus in the other account. The balance of trade is only one part of the overall balance of payments set of accounts.The balance of payments provides a country with a record of international payment flows. While the balance of trade is one important part of the balance of payments account it is only part. The balance of payments is a comprehensive set of accounts that track all sorts of payments coming in to and going out of a nation for a wide variety of reasons. Specifically the balance of payments is the difference between all payments coming into a nation and those going out of the nation. It is the balance of international monetary transactions for a nation. The balance of payments is effectively the difference between the funds received by a country and those paid by a country for all international transactions. These international transactions include (1) the exchange of merchandise (exports and imports), which is the balance on merchandise trade, (2) the exchange of services, summarized as the balance on services, (3) any gifts or transfer payments that do not involve the exchange of goods and services, and the (4) the purchase of physical or financial capital assets. The balance of payments is divided into two accounts -- current account (which includes payments for imports, exports, services, and transfers) and capital account (which includes payments for physical and financial assets). Balance of Payments for Northwest Queoldiola
The chart to the right presents the hypothetical balance of payments for Northwest Queoldiola stated in terms of queolds, the hypothetical Queoldiolan currency. The balance of payments for real world countries is generally stated in terms of their domestic currencies (such as dollars for the United States or reals for Brazil). First note that this chart contains two major sections, Current Account and Capital Account. Details about both are forthcoming. Near the bottom of the chart is then a summary Balance of the Current and Capital Accounts,which combines the two sections. At the very bottom is finally the overall Balance of Payments. Why the overall balance is zero but the summary balance is not is worthy of further discussion and is also forthcoming. Current AccountThe Northwest Queoldiola balance of payments chart at the right highlights the current account. The current account is a record of all trade between one nation and other nations. It includes payments for imports and exports of both goods and services. It also includes monetary gifts or transfer payments to and from other nations. This account is divided into three categories -- balance on merchandise trade, balance on services, and unilateral transfers.
Including unilateral transfers with the balance on goods and services provides a summary value of the balances of the current account, the last line in this section. Highlighting this can be done by clicking the [Cur Bal] button. For Northwest Queoldiola, this value is positive. Capital Account
A Balance of AccountsThis chart of the Northwest Queoldiola balance of payments highlights the summary balance portion of the statement. Interestingly, the balance on the current account for Northwest Queoldiola is a positive value and the balance on capital account is (almost) and equal negative value. Is this mere coincidence?Hardly. Summing the balance on the current account and the balance on the capital should, in theory at least, equal zero. That's what the "balance" in balance of payments is all about. Any net flow of payments for goods and services is offset by an equal but opposite net flow of payments for capital investments. In the balance of payments, the current account and capital account balance out to zero (in theory). This arises because the payments are made with the domestic currency of the nation (in this case, queolds used by Northwest Queoldiola). This currency is typically only the legal tender for the domestic economy and is, of course, limited in supply. Thus, any domestic currency that flows out of the country to purchase imports or invest in foreign assets must return (eventually) to the domestic economy to purchase exports or invest in domestic assets. What else could those in the foreign sector do with this currency? Let's look at this in other terms. A current account deficit arises if imports exceed exports (with adjustments for net transfers abroad). In this case, the domestic economy is sending more money out for these activities than it is receiving. A capital account surplus then arises if the foreign sector is buying relatively more domestic assets than the domestic sector is buying foreign assets. That is, the money flowing out of the domestic economy from the current account due to imports and exports is flowing back in to purchase domestic assets. This has an important implication. If the current account has a deficit, then the capital account has a matching surplus. Or if the current account has a surplus then the capital account has a matching deficit. While, in theory, the balance of payments is zero, in practice, measurement errors prevent an absolute balance. Note that while the summary Balance on Current and Capital Accounts is close to zero, it is NOT zero. It should be, but it is not. For this reason a "statistical discrepancy" is included that is exactly equal to be opposite of the Balance on Current and Capital Accounts. When combined, the Overall Balance is zero, exactly as it should be. Surplus or Deficit?The balance of payments account for a country, in theory, and thanks to the statistical discrepancy, in practice, achieve a balance. However, it is possible for a country to have a balance of payments surplus or deficit -- at least temporarily. Balance of payments surpluses or deficits can be achieved by fixing the currency exchange rate.
But such efforts cannot be maintained indefinitely. Eventually the country will pay out all of its domestic currency to other countries (with a balance of payments deficit) or domestically control all of the currency of other countries (with a balance of payments surplus). Neither of this options can actually occur. Check Out These Related Terms... | current account, balance of payments | capital account, balance of payments | balance on merchandise trade | balance on services | unilateral transfers | balance of trade | balance of trade surplus | balance of trade deficit | Or For A Little Background... | international finance | international trade | international economics | foreign trade | money | currency | open economy | closed economy | foreign sector | domestic sector | And For Further Study... | foreign exchange market | international market | free trade areas | trade barriers | foreign exchange | exchange rate | flexible exchange rate | fixed exchange rate | managed flexible exchange rate | Recommended Citation: BALANCE OF PAYMENTS, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2024. [Accessed: May 18, 2024]. |