A nation's bank account

Just as you keep track of your cash, a nation tracks the money coming into and going out of the country. It uses an annual accounting record, known as the balance of payments, to track all of its monetary transactions with other countries.

A country’s balance of payments includes exports, imports, foreign aid, business investment abroad, and money spent by tourists. Money coming into a country, exports, and money spent by tourists increase the balance of payments. Imports and business investment abroad, on the other hand, represent money going out and therefore reduce the balance of payments.

Just like you and businesses, a nation needs to make more money than it spends. A favorable balance of payments occurs when more money comes in than goes out. If the balance of payments is unfavorable, a country’s leaders need to review and change its trade policies.

If you look at the difference between the value of a nation’s imports and exports, you can see the country’s balance of trade. When a country exports more goods and services than it imports, a trade surplus exists. Trade surpluses can increase the value of a nation’s currency and improve its standard of living. In effect, a trade surplus increases a country’s gross domestic product.

On the other hand, if a country (such as the U.S.) imports more than it exports, a trade deficit exists. Trade deficits can lower the value of a country’s currency and result in fewer job opportunities, thereby reducing a country’s gross domestic product.