The balance of payments records economic transactions with foreign countries for a specific observation period. In the context of the balance of payments, the current account, trade and services as well as the money flows are compared. The Deutsche Bundesbank publishes the balance of payments for Germany once a month. In contrast to a balance sheet in the business sense, the balance of payments records flows, not stocks. Similar to a business balance sheet, however, it is also based on double bookkeeping, which must be balanced in the end.
- The balance of payments is divided into the current account and the capital account.
- The cause of a surplus lies in increased exports due to lower production costs.
- A balance of payments deficit is primarily based on a strong currency and falling exports.
- Balance of payments surpluses are easier to correct in foreign business, but they also harbor dangers.
The structure of the balance of payments
Short for BOP by abbreviationfinder, the balance of payments is divided into the current account and the capital account. The structure is analogous to a specification of the International Monetary Fund (IMF).
Components of the current account
- Trade balance and movement of goods
- Supplementary items on the movement of goods (e.g. transport costs)
- Balance of purchases and assets
- Balance of current transfers
- Balance of asset transfers
Components of the financial account
- Capital account balance (securities transactions, direct investments, capital movements)
- Foreign exchange balance (also takes into account the change in currency reserves)
- Remaining items and balance of unrecorded transactions
Interpretation of the balance of payments
There are two possible states for the balance of payments. There is either a balance of payments surplus or a deficit. Both conditions have a direct impact on the domestic economy.
Balance of payments surplus
The cause of a surplus lies in increased exports due to lower production costs. The income of tax residents increases due to work abroad. A weakening of the local currency increases the tourism of foreign visitors.
Balance of payments deficit
A balance of payments deficit is primarily based on a strong currency and falling exports. In addition, there are high investment income domestically for foreign investors and an increase in trips abroad when one’s own currency strengthens against foreign currencies.
The effects of the two states of a balance of payments
In addition to the causes of the respective balance of payments result, the effects represent the more serious factor, as this has an impact on the future economy. It is not for nothing that balanced foreign trade is part of the Stability Act.
The consequences of a balance of payments surplus
The domestic money supply is increasing. This can lead to so-called “imported inflation”. The demand for credit falls, and with it, interest rates fall too. Full employment is a positive aspect, but it also leads to inflationary approaches.
The consequences of a balance of payments deficit
These consequences are inevitably the opposite of the consequences of an excess. The domestic money supply is falling, there is an increasing demand for loans and thus an increase in interest rates. If your own currency has an overhang on the foreign exchange market, it sinks in value. Imports are cheaper for foreign companies, which leads to a short-term increase in production and employment, but is a trend that sooner or later turns into the opposite. The loss of jobs consequently leads to a decline in the inflation rate and domestic demand.
The solution to imbalances in the balance of payments
Balance of payments surpluses are easier to correct in foreign business, but they also harbor dangers. Since the increased exports and the simultaneous rise in foreign exchange result in a gap in the domestic product range and thus an artificial shortage, the risk of inflation increases. Balance of payments deficits can be leveled out, for example, by subsidizing foreign business. These include export guarantees or the removal of embargoes or export premiums.
In return, balance of payments surpluses can be controlled by throttling exports. At the same time, foreign trade subsidies are being abolished. At the same time, it is important to strengthen imports. Possible approaches are also the lifting of tariffs or other restrictions.