SummaryAn economy’s openness must be measured considering multiple variables. For instance, all countries are considered open economies to some degree, but not all allow free movement of capitals across borders. Others might have governments that control information flows and Internet service. In this LP, we learn to analyse an open economy from a purely economic point of view, looking at their net exports and their Balance of Payments.
The financial account is one of the components of the balance of payments. It shows the net acquisition and disposal of both financial assets and liabilities. As stated in the sixth edition of the Balance of Payments Manual (BPM), by the International Monetary Fund, “The financial account records transactions that involve financial assets and liabilities and that take place between residents and nonresidents”. The table below, taken from the BPM, shows an overview of the financial account.
The financial accounts may correspond to either entries to goods, services, income or capital account, or to entries of opposite sign to the financial account itself. For instance, when a country sells goods to another country, there will be an entry in the current account (an increase in the goods and services account, since the country is exporting), but also an entry in the financial account, such as currency, deposits or trade credit. Sometimes, entries in the financial account will be matched by other entries in the same account: bonds may be exchanged for deposits or currency.
Therefore, the balances of both the current account and the capital account will be conceptually equal to the net balance of the financial account, as seen in the following formula:
CAB + KAB = NFA
CAB = current account balance
KAB = capital account balance
NFA = net financial account
This must be understood as follows: the sum of the balances on the current and capital accounts represent the surplus(net lending) or deficit(net borrowing) that an economy has with the rest of the world. This is equal to the financial account, since it measures how the net lending or borrowing from non-reside