Economics Assignment: Balance of Payments, Current & Capital Accounts

This report provides a detailed analysis of the balance of payments, a crucial accounting measure in international economics. It begins by defining the balance of payments and highlighting its significance in tracking a nation's financial transactions with the rest of the world. The report then delves into the components of the balance of payments, specifically the current, capital, and financial accounts. The current account, also known as the balance of trade, includes exports and imports of goods and services, as well as unilateral transfers and investment income. The capital account covers capital transfers, including debt forgiveness and transfers of financial assets by migrants. The financial account encompasses foreign direct investment and foreign portfolio investment. Finally, the report examines the importance of the U.S. trade deficit, discussing how the imbalance between exports and imports impacts the current account and, consequently, the overall balance of payments. It explains how deficits in the current account necessitate surpluses in the capital and financial accounts to maintain balance and discusses the implications of the US trade deficit for the economy and investor confidence. The report also references the causes of trade deficit such as trade war and appreciation of dollar.

Running head: ECONOMICS
Economics
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Table of Contents
Question 1........................................................................................................................................2
Importance of Balance of Payment as an accounting measure....................................................2
Question 2........................................................................................................................................2
Different accounts of Balance of Payment..................................................................................3
Question 3........................................................................................................................................4
Importance of U.S trade deficit for balance of payment.............................................................4
References........................................................................................................................................6

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Question 1
Importance of Balance of Payment as an accounting measure
Balance of payment of a nation refers to the specific record that a country maintains for
accounting all the transaction between resident and business organization of a nation and other
countries as well. It involves all the exchanges in affairs made in terms of money. The balance of
payment is a well-structured accounting measure which divides all the transaction occurring in
the nation into three separate accounts – current account, capital account and financial account.
Each account includes separate components of transaction and adjusts in such a way that balance
of payment always remains at a balance state (Haughton, 2017). Overall, balance of payment is
considered as a vital record or accounting all the financial transaction and therefore reflect
financial state of the nation. Balance of payment is very important since it analyzes the business
transactions recorded as export and import of goods and services taken place in a particular
accounting year. This helps the government to identify the areas having considerable export
potential and hence, help in policy formulation. In order to make investment decision into a
nation investors need to analyze economic vulnerability of the targeted sector. For getting
maximum return from investment investors scrutinize state of balance of payment. For example,
an investor can suffer loss if investment is made in banking sector where financial scales are
exposed to risk. International trade determines capacity of a country (Gandolfo, 2016). The
balance of payment account is examined to determine whether the country is able to make
payment for imports out of exports. State of balance of payment has been examined by investors
to check whether a nation is running with surplus or deficit. The monetary exchange of a nation
reflected from its balance of payment account determines vulnerability of the nation to the
external shocks.

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Question 2
Different accounts of Balance of Payment
Current account and its components
The current account of balance of payment is also termed as the balance of trade. The
current account constitutes a major part of balance of payment since it includes major
transactions corresponding to goods and service exchange that entail monetary transfer. The
main components of current account in the balance of payment account include
Export of goods and services
Import of goods and services
Unilateral transfers like remittances, gifts and donations (Uribe & Schmitt-Grohe, 2017).
Investment income obtained from abroad along with payment made to foreign investors for
making investment on the native soil.
Capital account and its components
All the capital transfers are accounted in the capital account of balance of payment. The
overall income and expenditures are measured in terms of inflow and outflow of funds taking
form of loans and investment. Deficit in capital account means more funds are flowing outside
while a surplus in capita account means more funds are coming in. The capital account along
with including non-produced and non-financial assets transactions also include the following
Dealings like forgiveness of debt.
Transfer of financial assets by migrants (Hellerstein & Tille, 2008).

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Transfer of ownership over the fixed assets
Patents, death levies, royalties and copyright
Financial account and its component
The financial account includes both foreign direct investment and foreign portfolio
investment. It is further divided into two sub categories – one that maintains domestic ownership
on foreign assets and other that records foreign ownership on domestic assets. If domestic
ownership over foreign assets increase then overall financial account improves (Stein, 1993). In
contrast, if foreign ownership over the domestic assets increases, the overall financial account
worsens.
Question 3
Importance of U.S trade deficit for balance of payment
The trade deficit of United State in 2019 was stood at $616.8 billion. During this year, the
value of imported goods in U.S. was $3.12 trillion of goods and services while the value of
export amounted to $2.5 trillion. On-going trade war and appreciation of dollar are the two
significant reasons for growing trade deficit. The difference between export and import has a
significant influence on balance of payment of the nation with res the world by influencing
balance in the current account (Reinbold & Wen, 2018). All other components of current account
only have a minor role. Trade balance being one vital component of current account growing
trade deficit leads to an increase in current account deficit. In the last four decades, current
account deficit of US widened along with an increase in trade deficit. The net asset income
component of current account in contrast has increased steadily. However because of the large
trade deficit the increase in net asset income has only a small contribution in moving current

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account balance. In 2018, current account deficit of US was $492 billion (thebalance.com, 2020).
The current account deficits in turn reflect how much more citizens, business and American
government are borrowing compared to what they are lending. The main factor responsible for
current account deficit was the trade deficit of US. US trade deficit with rest of the world during
this time was $627billion. The balance of payment account of a nation always balances. Because
of the increasing current account deficit other accounts such as capital and financial account
should have surpluses (Van Marrewijk, Ottens & Schueller, 2012). Because of the widening
current account deficit, the capital and financial account has to adjust to maintain balance in the
balance of payment account. It is due to the large current account deficit which raises doubt
ability of nation to pay sufficient return to the investors.

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References
Gandolfo, G. (2016). The Balance of Payments. In International Finance and Open-Economy
Macroeconomics (pp. 67-83). Springer, Berlin, Heidelberg.
Haughton, A. (2017). Balance of Payments and Capital Account Sustainability. In Developing
Sustainable Balance of Payments in Small Countries (pp. 89-102). Palgrave Macmillan,
Cham.
Hellerstein, R., & Tille, C. (2008). The changing nature of the US balance of payments. Current
Issues in Economics and Finance, 14(4).
Reinbold, B., & Wen, Y. (2018). Understanding the Roots of the US Trade Deficit. The Regional
Economist, 26(3).
Stein, H. (1993). Balance of payments. Concise Encyclopedia of Economics.
thebalance.com (2020) How the US Trade Deficit Hurts the Economy. The Balance. Retrieved 18
March 2020, from https://www.thebalance.com/u-s-trade-deficit-causes-effects-trade-
partners-3306276
Uribe, M., & Schmitt-Grohe, S. (2017). Open economy macroeconomics. Princeton University
Press.
Van Marrewijk, C., Ottens, D., & Schueller, S. (2012). International economics. Oxford
University Press.