Why current and capital accounts net out (video) | Khan Academy
Guide to top differences between Current Account vs Capital account. Here we also discuss key differences with examples, infographics, & comparison table. Jul 12, The balance of payments of a country contains two accounts: current and capital. The current account records exports and imports of goods and. The balance of payment comprises two accounts: Current Account and Capital Account. Simply put current account records exports and imports of goods;.
The balance on the capital and financial account is achieved by adding the categories of the account together.
Why current and capital accounts net out
In order to achieve the balance of payments the balance on the current account and the balance on the capital and financial account are added together. These should add together and if there is a slight imbalance this is accounted for in the net errors and omissions section. Thus we have the balance of payments. The financial inflow on the capital and financial account is needed to finance the deficit on the current account.
Additionally, financial inflows coming into Australia increase the size of our net income deficit. This is the case as financial inflows require some sort of return, which is recorded as an outflow on the net income section of the current account.
Loans from overseas require the amount to be paid back as well as debt servicing costs. Foreign assets holdings in Australia require return such as dividends or rent.
Thus as financial inflows increase the amount of money flowing out on the net income section increases as well. This results in a larger deficit on the current account. Another relationship between the two accounts is the levels of saving and investment in Australia. Australia has a historically low level of savings and a small population. Thus we require a large financial inflow to finance investment.
Balance of Payments and Exchange Rates The balance of payments will be affected by the exchange rate. Appreciations and depreciations of the rate will both have positive and negative effects.
Other things being equal this would cause a fall in demand. Thus, the balance on goods and service would deteriorate worsening the CAD. As imports become cheaper, consumption of these goods will increase. This deteriorates balance on goods and services as well as the CAD.
This reduces income inflows, deteriorating the CAD. This is known as the valuation effect. Additionally, the overall value of foreign debt will also fall.
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- Differences Between Current Account vs Capital Account
Depreciation and the Balance of Payments If the value of the dollar is reduced, the cost of debt servicing as well as the overall value of foreign debt is increased. The capital is invested and expended in making the international trade happen. Affect changes in Current account affects the net income of the country. Capital account affects the current account or the financial account either to reduce trade deficit or to increase trade surplus.
Deals with International trade, receipt of cash non-capital items etc. The application of the capital and how they are sourced. Balance of payment Current account is one component of the balance of payment. Capital account is also another component which constitutes the balance of payment.
Difference between Current Account and Capital Account
Conclusion Capital account and current account both are very complex aspects of balance of payments. And understanding them totally in this short scope would be impossible. However, we highlighted the key areas of both current account and capital account so that you can get an overview of how they work. Another component that we never talked about here is financial account.
Current Account vs Capital Account | Top 5 Differences (Comparison)
In short, financial account deals with the claims of financial assets of foreign countries. It includes portfolio investment, direct investment, reserve assets etc.
It is a major component of the balance of payments and the amount of transaction under a financial account is usually pretty large.