by Zach Fry, Program Manager, Policy and Research, and Tenley Smith, Senior Program Associate

What is the balance of payments?

The balance of payments summarizes the economic transactions of an economy with the rest of the world. These transactions include exports and imports of goods and services the purchase and sale of financial assets. The balance of payments is an important economic indicator for economies that engage in international trade because it summarizes how resources (both goods and capital) flow between a country and its trading partners.

The balance of payments is made up of a current account—largely consisting of trade flows—and a capital account, which consists of financial flows between nations. These must always be equal, and changes in one thus require a corresponding adjustment in the other. Such changes can flow in both directions depending upon the policy or economic shift that spurs a movement in the balance of the accounts. 

Changes in the financial flows in the capital account create changes in the current account often via changes in foreign currency valuation, which affect trade competitiveness. Likewise, the current account affects the capital account as changes in trade imbalance affect currency valuations.

How can the capital account affect the current account?

Capital Account Increase

Capital Account Decrease

How can the current account affect the capital account?

Trade Surplus

Trade Deficit

The balance of payments identity can help demonstrate how changes in capital flows and trade interact with each other and often affect currency demand and therefore valuation. Similarly, such balances can be influenced by changes in a country’s fiscal policy as that affects the supply of domestic saving.

Featured authors: 

Zach Fry, Program Manager of Policy and Research, Bretton Woods Committee

Tenley Smith, Senior Program Associate, Bretton Woods Committee