Taking a Closer Look at the Balance of Payments
The balance of payments is just about the money coming into and going out of a country. Here, we take a closer look – useful information for those studying for any of the CII R02, J10, J12, or AF4 exams.
Essentially, the balance of payments records the:
- flow of money into a country, e.g. payments from goods that the UK has exported.
- flow of money out of a country, e.g. payments for goods that the UK has imported.
Flows of money between the UK and the rest of the world are measured in the capital account and in the current account.
The Capital Account
The capital account reflects net changes in ownership of national assets – for example, when someone comes to this country, their assets become part of the UK’s total assets, or if a Japanese company built a factory in the UK, this would be included in the UK capital account.
The capital account also includes portfolio investment, so investing in assets such as shares in overseas companies, financial derivatives, and reserve assets held by the Bank of England.
The Current Account
The current account records the international exchange of goods and services and is made up of four sections:
- Trade in goods – also known as visible trade – for example, cars and food
- Trade in services – also known as invisible trade – for example, tourism and insurance
- International flows of income earned as salaries, interest, dividends, and profit
- Transfers of money from one government (or person) to another – for example, foreign aid
The Balance of Trade
The difference between exports and imports is known as the balance of trade. If the UK exported more than it imported, and therefore the money flowing in exceeded the money flowing out, then we would be running a trade surplus. Conversely, if the money flowing out is more than the money flowing in, there will be a trade deficit. The UK has had a current account deficit for many years caused largely by the deficit in trade in goods, which basically means the UK has been importing more goods and services than it has been exporting.
Dealing with a Current Account Deficit
One way of dealing with a current account deficit is to devalue the exchange rate – this would make exports cheaper and imports more expensive leading to a fall in demand. This would (in theory at least) improve the current account deficit.
The current account should, in theory, balance the capital account; in other words, a deficit on the current account should be offset by a surplus on the capital account.
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