Study Notes
The balance of payments is a record of all transactions between a country's residents and the rest of the world, consisting of the current account, capital account, and financial account. It must balance, meaning the sum of all credits equals the sum of all debits.
- Current Account — records the balance of trade in goods and services, net income, and net current transfers. Example: A country with a surplus in services exports more services than it imports.
- Capital Account — includes capital transfers and transactions in non-produced, non-financial assets. Example: Debt forgiveness is a capital transfer.
- Financial Account — records foreign direct investment, portfolio investment, reserve assets, and official borrowing. Example: A positive balance indicates more inflows of investment than outflows.
Exam Tips
Key Definitions to Remember
- Balance of Payments
- Current Account
- Capital Account
- Financial Account
- Deficit
- Surplus
Common Confusions
- Confusing the components of the current account with those of the capital account.
- Misunderstanding the need for the balance of payments to always balance.
Typical Exam Questions
- What is the balance of payments? It is a record of all transactions between a country's residents and the rest of the world.
- How does a current account deficit relate to the financial account? A current account deficit is often offset by a surplus in the financial account.
- What are the main components of the current account? Balance of trade in goods and services, net income, and net current transfers.
What Examiners Usually Test
- Understanding of how the balance of payments is structured.
- Ability to explain the interdependence between different accounts.
- Calculation of deficits and surpluses from given data.