The balance of payments is the record of every transaction between one country and the rest of the world over a period. In AP Macroeconomics it has two main parts. The current account records trade in goods and services, plus income and transfers across borders. The financial account records purchases and sales of assets such as shares, bonds, property and bank deposits. A small capital account covers items such as some transfers of ownership of non produced assets.
Because every purchase from abroad has to be paid for, the accounts balance in principle. A current account deficit is matched by a financial account surplus, meaning a net inflow of foreign financial capital. Official statistics show a statistical discrepancy as well, because real world data are incomplete. Educational only. This page uses no figures, and the official numbers are in the sources below.
The accounts and what goes where
| Account | What it records | Examples |
|---|---|---|
| Current account | Goods and services trade, primary income such as interest and dividends, secondary income such as transfers | Exports of cars, imports of software services, dividends paid to foreign shareholders |
| Capital account | Capital transfers and some non produced, non financial assets | Debt forgiveness, sale of a patent right in some treatments |
| Financial account | Cross border purchases and sales of financial assets and direct investment | A foreign firm building a US factory, a UK pension fund buying US Treasury bonds |
Sorting transactions, AP style
Ask two questions. First, is it a good or service, income or transfer, or is it an asset? Goods, services, income and transfers go in the current account. Assets go in the financial account. Second, does money flow in or out? Money flowing in, such as an export sale or a foreigner buying a domestic bond, is a credit. Money flowing out is a debit.
- A US firm sells machinery to a buyer in Japan: current account, credit for the United States.
- A US household buys a German car: current account, debit.
- A Canadian investor buys shares in a US company: financial account, inflow for the United States.
- A US bank buys UK government bonds: financial account, outflow.
Why the accounts balance
If the United States imports more than it exports, foreigners receive more dollars than they spend on US goods and services. They use those dollars to buy US assets, which shows up as a financial inflow. So in principle the current account balance plus the capital account balance equals the net inflow on the financial account, and official tables add a statistical discrepancy to close any gap. This is also why a current account deficit means a country is a net borrower from the rest of the world over that period.
Links to the foreign exchange market
Each transaction needs a currency trade. Foreigners buying US exports or US assets demand dollars, and Americans buying imports or foreign assets supply dollars. The graph for that is on the foreign exchange market page. Higher real interest rates at home, from the loanable funds market, tend to raise financial inflows. Net exports are also a part of GDP, explained on the BEA versus ONS GDP page.
Common AP exam mistakes
- Putting a purchase of foreign shares in the current account. Assets go in the financial account.
- Calling a current account deficit a sign that money is lost. It is matched by a financial inflow.
- Counting interest and dividends as financial account items. They are income, so they go in the current account.
The full unit list is on the AP Macro review hub, and definitions are in the glossary.
Sources
- BEA, US International Transactions
- ONS, UK Balance of Payments
- College Board, AP Macroeconomics course page, Unit 6 Open Economy
Common questions
What is the difference between the current account and the financial account?
The current account records trade in goods and services plus cross border income and transfers. The financial account records purchases and sales of assets such as shares, bonds and direct investment.
Why does a current account deficit match a financial account surplus?
When a country buys more from abroad than it sells, foreigners end up holding extra domestic currency. They use it to buy domestic assets, which is a financial inflow. Official tables also show a statistical discrepancy.
Where do interest and dividend payments go in the balance of payments?
They are primary income, so they go in the current account, not the financial account.
Is buying a foreign company's shares a current account item?
No. Shares are financial assets, so the purchase is a financial account outflow for the buyer's country.