FINM8007 Chap.3 The Balance of Payments
The Balance of Payments
Two entries for every transaction
The balance of payments records every economic transaction between a country’s residents and foreign residents over a period, using double entry.
This chapter sets out the current account, the capital and financial account and the official reserves account, and the sign rule that a credit is foreign exchange earned and a debit is foreign exchange spent.
Entries, identities and imbalances
A three-step routine handles any transaction question, including gifts and payments made from accounts at home or abroad.
The chapter closes with the BOP identity, errors and omissions, what surpluses and deficits mean under floating and fixed rates, and the debate over persistent current account deficits.
Where marks are won and lost
The Week 3 workshop and the Tutorial 3 solutions work every entry in the same order: name the country’s BOP and the foreign currency, classify the primary transaction with its sign, then classify the payment with the opposite sign and a reason, always following the flow of foreign currency.
The Quiz 1 review shows the commonest slip, filing a purchase of foreign shares under the current account. Questions on imbalances reward the distinction between regimes: under a float the capital account finances a current account deficit, while under a peg the official reserves move instead.
How it connects
The balance of payments is the bridge to exchange rate determination.
Credits supply foreign currency and debits demand it, so the accounts in this chapter become the demand and supply schedules of Chapter 4, and a persistent imbalance under a peg becomes the reserve loss that forces a devaluation in Chapter 2’s regimes.
What this chapter covers
- 01
Current account items
- 02
Capital and financial account items
- 03
Official reserves
- 04
Credits and debits as FX flows
- 05
The three-step entry routine
- 06
The BOP identity
- 07
Surpluses and deficits by regime
Worked example · free
Record a software licence bought from a US vendor
- 1Step 1: it is Australia’s BOP and the foreign currency is the US dollar.
- 1Step 2: buying the licence is an import of services, so the current account is debited A$50,000.
- 1Step 3: the vendor now holds a claim on an Australian bank, so other investment in the capital account is credited A$50,000.
Key terms
- Current Account
- The BOP account for trade in goods and services, income and current transfers.
- Portfolio Investment
- Cross-border holdings of shares, bonds or other securities without control.
- Errors and Omissions
- The balancing line that absorbs measurement gaps so the BOP sums to zero.
- Official Reserves
- Foreign currencies, gold and SDRs held by the monetary authority.
- Capital Account
- The BOP account for cross-border purchases and sales of assets, including direct and portfolio investment.
The Balance of Payments FAQ
Is buying foreign shares a current account item?
No. Purchases of foreign shares or bonds are portfolio investment and belong in the capital and financial account. The current account records trade in goods and services, income such as dividends and interest, and current transfers.
Why must the balance of payments balance?
Each transaction is recorded twice, once as a credit and once as a debit, so the three main accounts sum to zero by construction. In practice measurement gaps and timing differences are absorbed by a net errors and omissions line.
Is a current account deficit bad for a country?
Not necessarily. It may signal spending beyond national saving, or it may reflect investors wanting to invest where risk-adjusted returns are high. Borrowing that funds profitable investment can be repaid; the danger lies in debt that future surpluses cannot cover.
How should I read a BOP surplus under a fixed exchange rate?
A combined current and capital account surplus means the central bank has been buying foreign currency to hold the peg, so its reserves grow and the official reserves account shows a deficit. A combined deficit drains reserves, and a bank that runs short may be forced to devalue.
Exam move
Write out twenty one-line transactions and book each with the three steps, saying in words whose claim changed. Then check every pair of entries nets to zero. Add one fixed-rate and one floating-rate case to the list and explain, in two lines each, which account finances the imbalance.
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