How the balance of payments is put together

Overview

Balance of payments, four components of the current account and trade in goods balance.

What you need to know

Answer each one before you reveal it.

Questions from this subtopic

Each one with the model answer underneath.

1. 1

   What is the balance of payments?

   Model answer

   The balance of payments is a systematic record of all economic transactions between the residents of one country and the rest of the world over a period, usually a quarter or a year. It covers trade in goods and services, income flows, transfers, and transactions in financial and other assets. It is an accounting statement of flows during the period, not a stock of what the country owns or owes.

2. 2

   Why is a balance of payments account compiled at all?

   Model answer

   It shows how a country is paying its way with the rest of the world: whether it is earning enough from selling goods, services and factor services abroad to cover what it buys, and if not, how the shortfall is being financed. Governments and central banks use it to judge external sustainability and competitiveness, investors use it to assess the risk of holding the country's assets and currency, and it provides the framework linking trade performance to borrowing, asset sales and reserves.

3. 3

   Into what main sections is a balance of payments account divided?

   Model answer

   The current account records trade in goods, trade in services, primary income and secondary income. The capital account records a small set of transactions in non-produced non-financial assets and capital transfers such as debt forgiveness. The financial account records transactions in financial assets and liabilities, including direct investment, portfolio investment, other investment such as loans and deposits, and changes in official reserves. A net errors and omissions item makes the whole account balance.

4. 4

   What is recorded as a credit and what as a debit in the balance of payments?

   Model answer

   A credit is a transaction that gives rise to a receipt of money from abroad, such as exporting a good, providing a service to a non-resident, receiving interest on a foreign asset, or selling an asset to a foreigner. A debit is a transaction giving rise to a payment abroad, such as importing a good, paying a dividend to a foreign shareholder, or acquiring an asset overseas. The balance on any section is the sum of its credits minus the sum of its debits.

5. 5

   What are the four components of the current account, and what does each one record?

   Model answer

   Trade in goods records exports and imports of physical, tangible products such as machinery, food, fuel and vehicles. Trade in services records exports and imports of intangibles such as financial services, insurance, tourism, transport, education and consultancy. Primary income records income earned from providing factors of production abroad, chiefly interest, profits and dividends on foreign assets, and compensation of employees. Secondary income records transfers for which nothing is received in return, such as foreign aid, contributions to international bodies and remittances sent home by workers abroad.

6. 6

   How do the trade in goods balance, the trade balance and the current account balance differ from one another?

   Model answer

   The trade in goods balance is exports minus imports of physical goods alone. The trade balance, sometimes called the balance of trade in goods and services, adds trade in services to that figure. The current account balance adds primary and secondary income as well, giving the fullest measure of whether the country's earnings from abroad cover its payments abroad on current transactions. A country can run a goods deficit and still have a current account surplus if its services and income flows are strongly positive.

Other ways to work this

The same content, four other ways.

What is inside Levo

Six ways to work the same material.