The balance of payments refers to a statement whose purpose is to explain the transactions of an economy with the other countries of the world. Such a statement covers a particular time frame. This is also referred to as the balance of international payments. It covers every transaction that occurs between the inhabitants of the nation with the remainder of the world. This includes income, goods, and services; liabilities and financial claims to the world; and transfers and remittances (like gifts).
A balance of payments tabulation will group all types of transactions into two different accounts. These are the current account and the capital account. In the current account are services, goods, present transfers, and income from investments. The capital account is mostly made up of financial instrument transactions. These are combined with a nation’s IIP international investment position to make up its complete international accounts.
The phrase balance of payments is somewhat of a misnomer as it does not pertain to any payments which an economy receives or makes. Instead it is only concerned with transactions. A great number of such international transactions do not have money payments involved with them. This explains how the number can be substantially different from the net payments a country affects to foreign countries, companies, and individuals.
The balance of payments is seldom an even zero sum figure without adjustments being made. There are typically either current account deficits or surpluses. When a current account deficit exists, this would mean that it had to be counterbalanced by net inflows to the capital and financial account. Current account surpluses would match capital and financial account outflows. Either situation balances out the number. Reality is that this data comes from a number of divergent sources so that there is always some error in measurement.
This combined data for balance of payments and international investment positions informs international and domestic economic policies. A country will use various economic policies to attempt to address imbalances in the payments as well as direct foreign investment levels.
There are also a range of economic policies that governments utilize to achieve particular objectives that pertain to the balance of payments. Examples of this abound. Countries may be interested in generating a larger amount of direct foreign investment in specific sectors of the economy. They could implement a series of policies that would encourage such investment.
Other countries may be more concerned with increasing their exports. To do this, they may try to lower the exchange value of their currency. By maintaining their currency value at lower depressed levels, they can make their exports less expensive to foreign customers. As exports grow, this would help them to increase their currency reserves as a consequence. How successful such policies prove to be and the impacts they have become clear in the BOP information.
The balance of payments should never be confused with the balance of trade. Balance of trade is the single biggest component which makes up the nation’s BOP. It only includes the variance between the country in question’s exports and imports over a particular time frame.