What is the Balance of Payments (BOP)?
The balance of payments (BOP) reflects all payments and obligations to foreigners vs. all payments and obligations received from foreigners. It's a record of all financial flows in and out of a country. In the United States, the Bureau of Economic Analysis calculates the BOP.
How the Balance of Payments Works
The BOP calculation goes beyond merely subtracting outflows from inflows. It is actually composed of three sub-accounts: the current account, the capital account, and the financial account, each of which have their own types of inflows and outflows.
- The current account is composed of merchandise trade, services, income receipts, and one-way transfers such as foreign aid.
- The capital account includes transfers of financial assets such as tax payments and transfers of titles to assets.
The fluctuations in these sub-accounts can indicate which sector of the economy is causing the discrepancy.
When the value of imports exceeds the value of exports, the resulting negative number is called a trade deficit. For example, if the value of imported items to the United States equaled $1 trillion last year, but the value of exported items from the United States equaled $750 billion, then the United States would have a negative $250 billion BOP, or a $250 billion trade deficit.
Why the Balance of Payments Matters
The BOP helps economists and analysts understand the strength of a country's economy in relation to other countries. For example, a country with a large trade deficit is essentially borrowing money to purchase goods and services, but a country with a large trade surplus is doing the opposite.
In some cases, the BOP correlates with the country's political stability because it is indicative of the level of foreign investment occurring there.
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