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In macroeconomics and international finance, the capital account also known as the financial account is one of two primary components of the balance of payments , the other being the current account. Whereas the current account reflects a nation's net income, the capital account reflects net change in ownership of national assets.
A surplus in the capital account means money is flowing into the country, but unlike a surplus in the current account, the inbound flows effectively represent borrowings or sales of assets rather than payment for work. A deficit in the capital account means money is flowing out of the country, and it suggests the nation is increasing its ownership of foreign assets.
The term "capital account" is used with a narrower meaning by the International Monetary Fund IMF and affiliated sources. The IMF splits what the rest of the world calls the capital account into two top-level divisions: Conventionally, central banks have two principal tools to influence the value of their nation's currency: Setting a higher interest rate than other major central banks will tend to attract funds via the nation's capital account, and this will act to raise the value of its currency.
A relatively low interest rate will have the opposite effect. Since World War II, interest rates have largely been set with a view to the needs of the domestic economy, and moreover, changing the interest rate alone has only a limited effect. A nation's ability to prevent a fall in the value of its own currency is limited mainly by the size of its foreign reserves: When a currency rises higher than monetary authorities might like making exports less competitive internationally , it is usually considered relatively easy for an independent central bank to counter this.
By buying foreign currency or foreign financial assets usually other governments' bonds , the central bank has a ready means to lower the value of its own currency; if it needs to, it can always create more of its own currency to fund these purchases. The risk, however, is general price inflation. The term "printing money" is often used to describe such monetization, but is an anachronism, since most money exists in the form of deposits and its supply is manipulated through the purchase of bonds.
A third mechanism that central banks and governments can use to raise or lower the value of their currency is simply to talk it up or down, by hinting at future action that may discourage speculators. Quantitative easing , a practice used by major central banks in , consisted of large-scale bond purchases by central banks.
The desire was to stabilize banking systems and, if possible, encourage investment to reduce unemployment. As an example of direct intervention to manage currency valuation, in the 20th century Great Britain's central bank, the Bank of England , would sometimes use its reserves to buy large amounts of pound sterling to prevent it falling in value. Black Wednesday was a case where it had insufficient reserves of foreign currency to do this successfully. Conversely, in the early 21st century, several major emerging economies effectively sold large amounts of their currencies in order to prevent their value rising, and in the process built up large reserves of foreign currency, principally the US dollar.
Sometimes the reserve account is classified as "below the line" and thus not reported as part of the capital account. Taking the example of China in the early 21st century, and excluding the activity of its central bank, China's capital account had a large surplus, as it had been the recipient of much foreign investment.
If the reserve account is included, however, China's capital account has been in large deficit, as its central bank purchased large amounts of foreign assets chiefly US government bonds to a degree sufficient to offset not just the rest of the capital account, but its large current account surplus as well. In the financial literature, sterilization is a term commonly used to refer to operations of a central bank that mitigate the potentially undesirable effects of inbound capital: The classic way to sterilize the inflationary effect of the extra money flowing into the domestic base from the capital account is for the central bank to use open market operations where it sells bonds domestically, thereby soaking up new cash that would otherwise circulate around the home economy.
In some cases, however, a profit can be made. This would create additional liquidity in foreign hands. The above definition is the one most widely used in economic literature,  in the financial press, by corporate and government analysts except when they are reporting to the IMF , and by the World Bank.
In the IMF's definition, the capital account represents a small subset of what the standard definition designates the capital account, largely comprising transfers. The largest type of transfer between nations is typically foreign aid, but that is mostly recorded in the current account. An exception is debt forgiveness , which in a sense is the transfer of ownership of an asset. When a country receives significant debt forgiveness, that will typically comprise the bulk of its overall IMF capital account entry for that year.
The IMF's capital account does include some non-transfer flows, which are sales involving non-financial and non-produced assets—for example, natural resources like land, leases and licenses, and marketing assets such as brands—but the sums involved are typically very small, as most movement in these items occurs when both seller and buyer are of the same nationality.
Transfers apart from debt forgiveness recorded in the IMF's capital account include the transfer of goods and financial assets by migrants leaving or entering a country, the transfer of ownership on fixed assets, the transfer of funds received to the sale or acquisition of fixed assets, gift and inheritance taxes, death levies, and uninsured damage to fixed assets. They typically amount to a very small amount in comparison to loans and flows into and out of short-term bank accounts.
Capital controls are measures imposed by a state's government aimed at managing capital account transactions. They include outright prohibitions against some or all capital account transactions, transaction taxes on the international sale of specific financial assets, or caps on the size of international sales and purchases of specific financial assets.
Following the Bretton Woods agreement established at the close of World War II, most nations put in place capital controls to prevent large flows either into or out of their capital account. John Maynard Keynes , one of the architects of the Bretton Woods system, considered capital controls to be a permanent part of the global economy. The inflows sharply reverse once capital flight takes places after the crisis occurs. An exception to this trend was Malaysia, which in imposed capital controls in the wake of the Asian Financial Crisis.
Fred Bergsten the large inbound flow into the US was one of the causes of the financial crisis of From Wikipedia, the free encyclopedia. For the accountancy use of the term, see Capital account financial accounting. International Financial Markets 3rd ed.