Lesson summary: The balance of payments
|balance of payments||a record of all funds going in and out of a country|
|current account (CA)||a record of international transactions that do not create liabilities|
|capital financial account (CFA)||a record of international transactions that do create liabilities; the capital and financial account includes official and private sales and purchases of financial assets, such as bonds.|
|factor income||the net of payments received and payments made on investments overseas; for example, if an American resident owns stock in a Japanese car company, any income earned on that stock is factor income in the U.S. current account.|
|remittances||money that is received from another country that is not in exchange for a good, service, or financial asset; for example, when someone is working abroad and sends money home to their family, that is a remittance.|
The current account (CA) and capital and financial account (CFA) records transfers and purchases between countries
Trade deficits and surpluses in the balance of payments
Key equation: The balance of payments
- Students new to the concept of balance of payments sometimes get confused about the “money” that is moving around in the capital and financial account. Changes in the capital and financial account impact the market for loanable funds, not the money market. When a country sends its financial assets to another country, it is really sending its savings. Recall that the supply of loanable funds is the sum of private savings, public savings, and net capital inflows. The capital and financial account tells you how much net capital inflow (or outflow) there is.
- The capital that is being sent to and from countries in the capital and financial account is financial capital, not physical capital. Whenever you use the word capital, it’s good practice to specify the kind of capital you are talking about. If you are talking about the stock of physical equipment that can lead to economic growth, say “physical capital.” If you are talking about the flow of financial assets between countries, say “financial capital.”
- Many people assume that a trade deficit is bad. deficits aren’t necessarily bad because a country can consume more goods than they could produce domestically. However, deficits do create a future liability that will eventually need to be paid.
Questions for review
- The nation of Panem ran a budget deficit. As a result, it increased borrowing in the market for loanable funds.