In the open economy, which two accounts make up the balance of payments, and what do they record?

• A. Trade balance and budget balance; they record exports and government spending
• B. Current account and capital/financial account; they record trade in goods/services, income, transfers, and net cross-border financial asset/liability flows; they should balance.
• C. Domestic investment account and savings account; they record investment and saving
• D. Tax collection and revenue account

Answer: (B)

The open-economy balance of payments is made up of two accounts: the current account and the capital/financial account. The current account records the trade in goods and services, plus income from abroad and payments to abroad, as well as unilateral transfers. In essence, it shows the net flow of goods, services, and cross-border income. The capital/financial account tracks net changes in ownership of foreign assets and liabilities—direct investment, portfolio investment, other investments, and reserve assets—showing how the economy finances any current account imbalance.

These two accounts are connected by the balance-of-payments identity: their sums should balance (aside from any measurement errors). So a current account deficit is financed by a capital/financial account surplus, and vice versa.

Other groupings like a separate trade balance or a budget balance don’t capture the full international flow of funds, and terms like domestic investment or savings accounts, or tax revenue, aren’t the components of the balance of payments.