Summary
The balance of payments tracks financial transactions between a country and the rest of the world, consisting of the current account and the capital and financial accounts. Current account records payments for goods, services, income flows, and cross-border transfers. Example: A country exporting more goods than it imports will have a current account surplus. Capital account includes non-produced, non-financial assets and capital transfers. Example: A country receiving a large donation from abroad will have a capital account credit. Financial account records financial capital flows, including foreign direct investment and portfolio investment. Example: A company investing in a foreign factory is recorded as a financial account inflow.
Exam Tips
Key Definitions to Remember
- Balance of payments
- Current account
- Capital account
- Financial account
Common Confusions
- Mixing up current account and capital account
- Assuming a surplus always indicates a strong economy
Typical Exam Questions
- If a country has a surplus on its current account, is it a net lender to the rest of the world or a net borrower from the rest of the world? Answer: A net lender to the rest of the world
- State two measures an economy might use to reduce a current account deficit. Answer: Currency devaluation and deflationary policies
- Why might running a persistent current account deficit be beneficial for an economy? Answer: It can finance long-term growth or bridge a savings gap
What Examiners Usually Test
- Understanding of the components of the balance of payments
- Causes and implications of current account deficits and surpluses
- Measures to correct imbalances in the current account