Question

Briefly explain the Balance of Payments national accounts system. What are the Capital and Current accounts? Why is this important information for countries to track?

Answer 1

• The balance of payments is the record of all international trade and financial transactions made by a country's residents.

The balance of payments has three components. They are the current account, the financial account, and the capital account.  

Capital Account:

• The capital account measures financial transactions that don't affect a country's income, production, or savings. For example, it records international transfers of drilling rights, trademarks, and copyrights. Many capital account transactions happen infrequently, such as cross-border insurance payments. The capital account is the smallest component of the balance of payments.

Current Account:

• The current account measures a country's trade balance plus the effects of net income and direct payments. When the activities of a country's people provide enough income and savings to fund all their purchases, business activity, and government infrastructure spending, then the current account is in balance.
• A current account deficit is when a country's residents spend more on imports than they save. To fund the deficit, other countries lend to, or invest in, the deficit country's businesses. The lender country is usually willing to pay for the deficit because its businesses profit from exports to the deficit country. In the short run, the current account deficit is a win/win for both nations.

But if the current account deficit continues for a long time, it will slow economic growth. Why? The foreign lenders will begin to wonder whether they will get an adequate return on their investment.

• The balance of payments system measures the operations of local economic units or actors, including the government, financial and non-financial businesses, and individuals. It also tracks the activity of non-resident actors within the national territory. The time frame is usually a year or a quarter-year.
• The balance of payments system is an important part of a country's macroeconomic statistics. This data provides useful information about economic performance--like the gross domestic product (GDP) and the net foreign investment (NFI)--and it allows governments to adjust or define economic policies. Businesses and investors also use it to plan operations.
• Each country collects information and keeps local records, so the specific accounts and the level of detail often change from one country to the other.

In this way, the Balance of payments national accounts system plays an  important role in country's growth.