Balance of Payments  Definition

Definition of Balance of Payments: The Balance of Payments shows a countries transactions with the rest of the world. It notes inflows and outflows of money and categorises them into different sections. The different sections of the Balance of Payments are:

Current Account Balanace of Payments

Measures transactions for goods and services.(used to be called visible and invisibles) The current account comprises the trade balance (which is trade in goods) and also includes the balance for trade in services.

When people refer to a balance of payments deficit they invariably mean a current account deficit

Financial Account (Capital) Balance of Payments

The financial account measures inflows of capital both short term and long term. this includes

  1. foreign direct investment
  2. Purchase of securities by investors

In a floating exchange rate a current account deficit must be matched by a surplus on the financial account.

Balance of Payments Crisis

This occurs when the current account deficit cannot be maintained. It means there will be a fall in foreign exchange reserves and the country can no longer attract sufficient capital flows to finance the current account deficit.

The solution to a balance of payments crisis is usually to devalue the currency and slow down consumer spending on imports, usually by causing a recession.

Russia experienced a balance of payments crisis in 1998, leading to devaluation of Rouble.

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