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Balance of payments

The current account

Definition

Balance of payments: a record of all of a country's transactions with the rest of the world.

Current account: the part of the balance of payments used as a performance indicator, covering trade and income flows.

  1. The current account has four components: trade in goods, trade in services, primary income and secondary income.
Note
  • Primary income covers earnings on investment, such as interest, profits and dividends flowing across borders.
  • Secondary income covers transfers with nothing given in return, such as foreign aid and remittances.

The balance of trade

Definition

Balance of trade: exports minus imports of goods and services.

balance of trade=exports−imports \text{balance of trade} = \text{exports} - \text{imports} balance of trade=exports−imports current account=trade balance+primary income+secondary income \text{current account} = \text{trade balance} + \text{primary income} + \text{secondary income} current account=trade balance+primary income+secondary income
  1. A country can run a deficit in goods trade while running a surplus in services, as the UK often does.
Example
  • Goods trade is −£40bn and services trade is +£25bn.
balance of trade=−40+25=−15 \text{balance of trade} = -40 + 25 = -15 balance of trade=−40+25=−15
  • Primary income is +£5bn and secondary income is −£10bn.
current account=−15+5−10=−20 \text{current account} = -15 + 5 - 10 = -20 current account=−15+5−10=−20 202000×100=1% \dfrac{20}{2000} \times 100 = 1\% 200020​×100=1%
  • So the current account deficit is £20bn, about 1% of a £2,000bn economy.

Deficits and surpluses

Definition

Current account deficit: more flows out than in on the current account items.

Current account surplus: more flows in than out on those items.

Financial account: the part of the balance of payments recording flows of investment and borrowing that finance a current account imbalance.

current account balanceGDP×100% \dfrac{\text{current account balance}}{\text{GDP}} \times 100\% GDPcurrent account balance​×100%
  1. Both the sign and the size relative to GDP matter when judging an imbalance.
  2. A deficit is financed through the financial account, for example by inflows of investment or borrowing from abroad.

Imbalances and objectives

  1. Current account imbalances are linked to other macroeconomic objectives such as growth, inflation and employment.
  2. A deficit may reflect strong domestic demand sucking in imports, while a large surplus may signal that demand at home is too weak.
  3. The seriousness of an imbalance depends on its size, its cause and how it is financed.
Note
  • The UK has run a persistent current account deficit, often around 3-4% of GDP, cushioned by a surplus in trade in services such as finance.
  • That deficit is financed by net inflows on the financial account, including foreign investment.

Global interconnectedness

Definition

Interconnectedness: the way trade and financial links tie economies together, so events in one spill over to its partners.

  1. International trade links economies, so one country's imports are another country's exports.
  2. One country's current account deficit is matched by surpluses elsewhere, so the balances across the world sum to zero.
  3. This interconnectedness means a slowdown or policy change in one economy spreads to its trading partners.

Is a current account deficit a problem?

  1. It holds because a large, persistent deficit means a country consumes more than it produces and relies on financing from abroad, which can threaten the currency if inflows dry up.
  2. But a deficit can be benign when it funds productive investment or reflects strong growth pulling in imports, and it is easily financed while foreign capital is willing to flow in, as in the UK.
  3. But the sign alone is not decisive: a large surplus can equally signal weak domestic demand, and since global balances sum to zero, not every country can run a surplus.
  4. On balance, whether a deficit is a problem depends on its size relative to GDP, its cause, and whether the financing is stable and sustainable.
Exam technique
  • Distinguish the balance of trade from the whole current account, and the current account from the whole balance of payments.
  • Judge a deficit or surplus by its size relative to GDP, its cause and how it is financed.
Common Mistake
  • Do not treat the whole balance of payments as the current account, and do not leave out primary and secondary income.
  • Do not assume a deficit is always bad or that only deficits matter, since large surpluses can also signal an imbalance.
Self review
  • Name the four components of the current account.
  • What is the balance of trade?
  • How is a current account deficit financed?
  • How are current account imbalances linked to other macroeconomic objectives?
  • Why is one country's deficit another country's surplus?
Recap questions

1 of 5

In one year, a country exports £160bn of goods and £90bn of services, and imports £210bn of goods and £60bn of services. What is its balance of trade?

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Flowchart showing the balance of payments split into current account, capital account, financial account, and net errors and omissions, with the current account branching to trade in goods, trade in services, primary income, and secondary income, plus a note that credits are payments into the country and debits are payments out

The balance of payments is the record of all economic transactions between residents of a country and the rest of the world over a period, usually a year. It includes trade, income flows, transfers and financial flows, so it is wider than trade alone.

A payment into the country from abroad is a credit, while a payment out of the country is a debit. In exams, say current account deficit or current account surplus unless you genuinely mean the whole accounting framework.

The current account is the main focus here because it links international flows to growth, inflation, employment and exchange rates. The other parts are the capital account, the financial account and net errors and omissions.

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The balance of payments records all economic transactions between [     ] and [     ] over a period of time.

2.1.4 Balance of payments Revision Guide

  1. A Level
  2. /Economics
  3. /2.1.4 Balance of payments