Balance of payments and exchange rates

The balance of payments (BOP) records all transactions between residents and the rest of the world. The current account covers goods, services, income and transfers; the capital and financial account covers investment and lending; and the whole account must balance once reserve changes are included. The exchange rate is the price of one currency in terms of another, set by supply and demand in the foreign exchange market. Worked example: if the current account is -50 (deficit), the capital account is +60 (net inflow), the overall balance is +10 (surplus), so reserves rise by 10.