Measuring the Balance of Payments | tutor2u Economics
Study notes

Measuring the Balance of Payments

  • Levels: A Level, IB
  • Exam boards: AQA, Edexcel, OCR, IB, Eduqas, WJEC

What is the balance of payments?

The balance of payments (BOP) records all financial transactions made between consumers, businesses and the government in one country with others

Short revision video on the UK current account (balance of payments)

Chart shows the annual trade balance for the UK

Trade balance in goods for the UK - 2007 to 2017
United Kingdom:
  • The BOP figures tell us about how much is being spent by consumers and firms on imported goods and services, and how successful firms have been in exporting to other countries.
  • Inflows of foreign currency are counted as a positive entry (e.g. exports sold overseas)
  • Outflows of foreign currency are counted as a negative entry (e.g. imported goods and services)

For example, a positive value for X-M means a trade surplus, a negative trade balance means a trade deficit.

What is the basic structure of the balance of payments accounts?

Current Account

  1. Balance of trade in goods
  2. Balance of trade in services
  3. Net primary income (this includes incomes from interest, profits, dividends generated from foreign investment and also migrant remittances i.e. payments from people living and working overseas)
  4. Net secondary income (this includes (for the UK) our annual contributions to EU, spending military aid, overseas development aid etc.)

Capital account

  • Sale/transfer of patents, copyrights, franchises, leases and other transferable contracts, and goodwill
  • Transfers of ownership of fixed assets

Financial Account

This includes transactions that result in a change of ownership of financial assets and liabilities between UK residents and non-residents

  • Net balance of foreign direct investment flows (FDI)
  • Net balance of portfolio flows (e.g. inflows and outflows of debt and equity)
  • Balance of banking flows (e.g. hot money flowing in/out of banking system)

Balancing item (estimated errors & omissions)

Changes to the value of reserves of gold and foreign currency

Overall balance of payments = zero

Explaining the balance of payments accounts

Key terms to know when studying the balance of payments

Balance of payments

Records all financial transactions made between consumers, businesses and the government in one country with others

Balance of Payments Account

It consists of goods and services account, primary income account, secondary income account, capital account, and financial account.

Balance of trade

The value of exports of goods and services minus (-) the value spent on imported goods and services

Capital account

Sale/transfer of patents, copyrights, franchises, leases and other transferable contracts, and goodwill

Current account

The overall balance of trade in goods and services and net balance for primary and secondary income

Current account deficit

A deficit occurs when the value of imports of goods/services / investment incomes / secondary incomes is greater than the value of exports

Current account surplus

A surplus occurs when the value of exports of goods/services / investment incomes / secondary incomes is greater than the value of imports

Financial account

Includes transactions that result in a change of ownership of financial assets and liabilities betwen

Foreign direct investment

An investment made by a firm or individual in one country into business interests located in another country

Hot money (short term capital) flows

Money that moves rapidly around the global financial system seeking the best "risk-adjusted" rate of return

Investment income

The most common types of investment income are income on equity (dividends) and income on debt (interest)

Portfolio investment

Inflows and outflows of debt and equity

Primary income

Includes incomes from interest, profits, dividends generated from foreign investment and also migrant remittances i.e. payments from people living and working overseas

Remittances

Transfers of money across national boundaries by migrant workers

Secondary income

Includes spending on military aid, overseas development aid

Trade deficit

When the value of imported goods and services is higher than the value of a country's exports (M>X)

Trade surplus

When the value of exported goods and services is higher than the value of a country's imports (X>M)

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