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CAPITAL ACCOUNT, BALANCE OF PAYMENTS:

A subset of the balance of payments accounts that tracks the flow of currency and other monetary assets used to purchase financial and physical assets. This part of balance of payments tracks domestic investment in the foreign sector and foreign investment in the domestic sector. This is one of two primary subsets of the balance of payments. The other is the current account. A deficit or surplus in the capital account is matched by an opposite surplus deficit in the current account.
The capital account of the balance of payments is record of the flow of payments between one country and other countries that result from: (1) domestic purchases of financial and physical capital from the foreign sector and (2) foreign purchases of financial and physical capital from the domestic sector.

In essence, the capital account tracks investment by the domestic sector in foreign assets going in one direction and investment by the foreign sector in domestic assets going in the other direction. These investments are for the purchase of physical capital, such as factories and equipment, or financial capital, such as currency and bonds.

The two primary players in the capital account are businesses and governments. Businesses undertake the bulk of the investment in physical capital, which is used for the obvious purpose of engaging in production. Governments purchase a lot of currency, which is used by their central banks to undertake exchange rate policies.

Balance of Payments for Northwest Queoldiola

Capital Account, Balance of Payments
Capital Account


To illustrate the capital account of the balance of payments system of accounts, consider the Republic of Northwest Queoldiola, a hypothetical country that is well suited for this task. Other real world countries, such as the United States, Brazil, or Lichenstein, have similar accounts (albeit with different numbers).

The chart to the right presents the hypothetical balance of payments for Northwest Queoldiola stated in terms of queolds, the hypothetical Queoldiolan currency. The balance of payments for real world countries is generally stated in terms of their domestic currencies (such as dollars for the United States or reals for Brazil).

First note that this chart contains two major sections, Current Account and Capital Account. Near the bottom of the chart is a summary Balance of the Current and Capital Accounts, which combines the two sections. At the very bottom is the overall Balance of Payments.

Two Capital Account Components

In the middle of the Northwest Queoldiola balance of payments chart is the capital account. This portion of the chart can be highlighted by clicking the [Capital Account] button. The capital account includes the flow of payments used to purchase financial and physical assets. Some folks in the foreign sector purchase assets in the domestic economy. And some in the domestic economy purchase assets in the foreign sector. These purchases are be made by individuals, business, and even governments. This account is divided into two categories -- domestic investment in the foreign sector and foreign investment in the domestic sector.
  • Domestic Investment in Foreign Sector: A click of the [Dom Inv] button highlights this portion of the Capital Account. This is the net flow of payments used by those in the domestic economy to purchase financial and physical assets in other nations. The bulk of this category is purchases of foreign assets, especially physical capital, made by private domestic businesses. However, it also includes purchases of foreign assets, primarily financial assets, made by the domestic government (usually the central bank and usually in the conduct of exchange rate policies).

  • Foreign Investment in Domestic Sector: A click of the [For Inv] button highlights this portion of the Capital Account. This is the net flow of payments used by those in the foreign sector to purchase financial and physical assets in the domestic economy. Once again, the majority of these payments is for the purchase of domestic physical capital by foreign sector businesses. However, purchases of financial capital issued by the domestic government, especially currency, is notable.
Summing the outflow of payments by the domestic sector for foreign assets and the inflow of payments by the foreign sector for domestic assets generates the balance on the capital account. For Northwest Queoldiola, this value is negative, as can be highlighted with a simple click of the [Cap Bal] button.

Exchange Rate Policies

The purchase or sale of financial assets by the domestic government plays a key role in the conduct of exchange rate policies. Exchange rate policies, especially a managed flexible exchange rate, arise when government deems it necessary to adjust the foreign currency exchange rate. This task is undertaken by buying and selling domestic and foreign currency. These transactions then enter into the capital account portion of the balance of payments.

Current Account

The other half of the balance of payments is the ccurrent account. The current account is a record of all trade between one nation and other nations. It includes payments for imports and exports of both goods and services. It also includes monetary gifts or transfer payments to and from other nations. This account is divided into three categories -- balance on merchandise trade, balance on services, and unilateral transfers.

The sum of the balance on merchandise trade and the balance on services (excluding unilateral transfers) is technically termed the balance on goods and services and is more commonly termed the balance of trade. This value is positive if the exports of goods and services exceeds the imports of goods and services, which is a balance of trade surplus. A balance of trade deficit occurs if the exports of goods and services falls short of the imports of goods and services, and the resulting value is negative.

A Balance of Accounts

A comparison of the two halves of the balance of payments indicates that the balance on the current account for Northwest Queoldiola is a positive value and the balance on capital account is (almost) and equal negative value. Is this mere coincidence?

Hardly. Summing the balance on the current account and the balance on the capital should, in theory at least, equal zero. That's what the "balance" in balance of payments is all about. Any net flow of payments for goods and services is offset by an equal but opposite net flow of payments for capital investments. In the balance of payments, the current account and capital account balance out to zero (in theory).

While, in theory, the balance of payments is zero, in practice, measurement errors prevent an absolute balance. Note that while the summary Balance on Current and Capital Accounts is close to zero, it is NOT zero. It should be, but it is not. For this reason a "statistical discrepancy" is included that is exactly equal to be opposite of the Balance on Current and Capital Accounts. When combined, the Overall Balance is zero, exactly as it should be.

<= CAPITALCAPITAL CONSUMPTION ADJUSTMENT =>


Recommended Citation:

CAPITAL ACCOUNT, BALANCE OF PAYMENTS, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2017. [Accessed: October 22, 2017].


Check Out These Related Terms...

     | balance of payments | current account, balance of payments | balance on merchandise trade | balance on services | unilateral transfers | balance of trade | balance of trade surplus | balance of trade deficit |


Or For A Little Background...

     | international finance | international trade | international economics | foreign trade | money | currency | open economy | closed economy | foreign sector | domestic sector |


And For Further Study...

     | foreign exchange market | international market | free trade areas | trade barriers | foreign exchange | exchange rate | flexible exchange rate | fixed exchange rate | managed flexible exchange rate |


Related Websites (Will Open in New Window)...

     | Federal Reserve System | World Trade Organization | North American Free Trade Agreement | General Agreement on Tariffs and Trade | European Union | International Monetary Fund |


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