Capital Account - The Capital Account in Macroeconomics

The Capital Account in Macroeconomics

At high level:

\begin{align} \mbox{Capital account} & = \mbox{Change in foreign ownership of domestic assets} \\ & - \mbox{Change in domestic ownership of foreign assets} \\ \end{align}

Breaking this down:

\begin{align} \mbox{Capital account} & = \mbox{Foreign direct investment} \\ & + \mbox{Portfolio investment} \\ & + \mbox{Other investment} \\ & + \mbox{Reserve account} \\ \end{align}
  • Foreign direct investment (FDI), refers to long term capital investment such as the purchase or construction of machinery, buildings or even whole manufacturing plants. If foreigners are investing in a country, that is an inbound flow and counts as a surplus item on the capital account. If a nation's citizens are investing in foreign countries, that's an outbound flow that will count as a deficit. After the initial investment, any yearly profits not re-invested will flow in the opposite direction, but will be recorded in the current account rather than as capital.
  • Portfolio investment refers to the purchase of shares and bonds. It's sometimes grouped together with "other" as short term investment. As with FDI, the income derived from these assets is recorded in the current account; the capital account entry will just be for any international buying or selling of the portfolio assets.
  • Other investment includes capital flows into bank accounts or provided as loans. Large short term flows between accounts in different nations are commonly seen when the market is able to take advantage of fluctuations in interest rates and / or the exchange rate between currencies. Sometimes this category can include the reserve account.
  • Reserve account. The reserve account is operated by a nation's central bank to buy and sell foreign currencies; it can be a source of large capital flows to counteract those originating from the market. Inbound capital flows (from sales of the account's foreign currency), especially when combined with a current account surplus, can cause a rise in value (appreciation) of a nation's currency, while outbound flows can cause a fall in value (depreciation). If a government (or, if authorized to operate independently in this area, the central bank itself) doesn't consider the market-driven change to its currency value to be in the nation's best interests, it can intervene.

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