Q: Please explain the difference between the current and the capital account on the balance of payments
The current account is the
Trade in goods
Trade in services
Net investment income from external assets
Capital account captures inflows and outflows of different forms of capital
Portfolio investment e.g. money flowing into / out of stock markets, pension funds, hedge funds etc
Direct capital investment e.g. fixed investment in factories
Short term banking flows ... also known as hot money
In principle a country running a current account deficit can ‘balance’ things up by running a surplus on the capital account - the UK is a good example, because the economy has been a favoured location for FDI and there is a strong appetite among foreign investors for UK government bonds
A country running a current account surplus can run capital account deficits i.e. invest heavily overseas or just accumulate foreign exxchange reserves e.g. China, Norway, Oil exporting nations .... some of whom have created their own sovereign wealth funds
In principle the BoP must balance .... it does so because of adjustments that countries make to their foreign exchange reserves using IMF agreed accounting measures and also because of the balancing item which reflects errors and ommissions!
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