Definition of Balance of Payments

Balance of Payments

One feature of double entry bookkeeping is that flows of money into and out of a country for various reasons have to balance in total. We can express a simplified view of this point as the balance of payments:

Current Account = Capital Account + Change in Official Reserves

Here the current account can be thought of as exports minus imports, which is often identified as the trade balance, plus net income on foreign assets and transfers. This net source of foreign currency must be offset by either net investment in foreign assets (the capital account) or changes in official reserves. (A statistical discrepancy is generally also added to account for difficulties in securing precise measurements of the various items.)

The balance of payments establishes a fundamental link between the factors affects goods transactions (exports and imports) and the factors affecting financial flows. For example, a country with a trade deficit (imports greater than exports) must have an interest rate (or other financial market considerations) that attract an offseting inflow of capital investment.

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