The current account of the balance of payments is record of the flow of payments between one country and other countries that result from: (1) the exchange of merchandise (exports and imports), which is the balance on merchandise trade, (2) the exchange of services, summarized as the balance on services, and (3) any gifts or transfer payments that do not involve the exchange of goods and services, which is unilateral transfers.
The commonly termed balance of trade is that portion of the current account that includes or is the sum of the balance on merchandise trade and the balance on services.
The balance of payments is actually divided into two accounts -- current account (discussed here) and capital account (which includes payments for physical and financial assets). A deficit in one account is matched by a surplus in the other, meaning the overall balance in the balance of payments is zero.
Balance of Payments for Northwest Queoldiola
To illustrate the current 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).
|Current Account, Balance of Payments|
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.
Three Components of the Current AccountThe first part of the Northwest Queoldiola balance of payments chart is the current account. This portion of the chart can be highlighted by clicking the [Current Account] button. 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.
- Balance on Merchandise Trade: A click of the [Mer Bal] button highlights the first portion of the Current Account. This is the difference between the payments received for exports of goods to other nations and the payments made for the imports of goods from other nations. The goods included are physical or tangible goods, but not intangible services. The balance merchandise is thus appropriately divided into Merchandise Exported and Merchandise Imported. Note Northwest Queoldiola exports more merchandise that it imports, hence the balance is a positive number.
- Balance on Services: A click of the [Ser Bal] button highlights the second portion of the Current Account. This is the difference between the payments received for exports of services to other nations and the payments made for the imports of services from other nations. This includes only intangible services. Once again a summary balance is provided for the trade in services, which for Northwest Queoldiola is negative, meaning that it exports fewer services than it imports.
- Unilateral Transfers: A click of the [Un Tran] button highlights the last portion of the Current Account. This is the difference between gifts or transfers received from other nations and transfers sent to other nations. In includes gifts or transfers between individuals, and perhaps more important, it includes transfers between governments. For Northwest Queoldiola transfers are positive because it receives more gifts from other countries than it gives out.
The Balance of TradeThe balance of trade is an important part of the current account of the balance of payments, but only part. The balance of trade is specifically identified as the sum of the balance on merchandise trade and the balance on services, which is technically termed the balance on goods and services.
Click the [Trad Bal] button for a look at this value for Northwest Queoldiola. 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.
Including unilateral transfers with the balance on goods and services provides a summary value of the balances of the current account, the last line in this section. Highlighting this can be done by clicking the [Cur Bal] button. For Northwest Queoldiola, this value is positive.
Worthy of a side note is the fact that the balance of trade, or the balance on goods and services, is only part of current, an important part, but only a part. As such, a balance of trade deficit of surplus can be reduced or enhanced by unilateral transfers.
Moreover, the balance of trade is also only part of the overall balance of payments. In fact the capital account portion of the balance of payments generally counterbalances the deficit or surplus position of the balance of trade, with an opposite surplus or deficit, which is what keeps the balance payments in "balance."
Capital AccountThe other half of the balance of payments is the capital account. The capital account includes the flow of payments used to purchase financial and physical assets. The capital account is separated into domestic investment in the foreign sector and foreign investment in the domestic sector. The first is the net flow of payments used by those in the domestic economy to purchase financial and physical assets in other nations. The second is the net flow of payments used by those in the foreign sector to purchase financial and physical assets in the domestic economy.
A Balance of AccountsA 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.
CURRENT ACCOUNT, BALANCE OF PAYMENTS, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2021. [Accessed: September 20, 2021].