When does the balance of payments balance?

• A. When the current account equals the capital account plus a balancing item
• B. When the current account equals the capital account minus a balancing item
• C. When the current account equals the capital account plus the change in central bank reserves
• D. When current account equals capital account plus or minus a balancing item plus or minus any change in central bank foreign currency and bank deposits

Answer: (D)

Balance of payments balances when inflows and outflows of foreign exchange are recorded so that the entire account sums to zero, after including measurement errors (the balancing item) and changes in official reserves. The official record shows that the current account, the capital/financial account, the balancing item, and any change in central bank reserves must add up to zero. Put another way, the current account equals the capital account plus or minus the balancing item plus or minus any change in central bank foreign currency and bank deposits. This shows why all four pieces—capital account, the balancing item, and reserve changes—must be included for a true balance.