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Using a person's budget to understand the balance of payments

Just like a personal budget, the balance of payments uses the sources of funds and uses of funds to track the movement of money. In this article, we use a young wizard's budget to make the BOP more relatable.
To get a better understanding of the balance of payments accounts, let’s think of a single person’s sources of funds and uses of funds. We can summarize Harry’s budget for this month as shown in the table below:
Source of funds or use of fundsAmount
Income earned from selling copies of his book “Talking to snakes for fun and profit”+$\mathrm{}1000$
Income earned from owl consultancy services+$\mathrm{}200$
Money spent on dementor repellant$-\mathrm{}1200$
Money spent paying for investment advice$-\mathrm{}300$
Payment from Ron to borrow Harry’s wand$+\mathrm{}50$
Allowance from Aunt Petunia$+\mathrm{}2$
Harry’s balance$-\mathrm{}248$
Uh oh! Harry ran a little short this month!
Suppose there was one more thing that Harry hasn’t included yet: he also loaned Lucius $\mathrm{}70$. That means he also has a financial asset in the form of an I.O.U. from Lucius, but also $\mathrm{}70$ less money available to him. That means Harry has a total shortfall of cash of $\mathrm{}248+\mathrm{}70=\mathrm{}318$. As usual, his friend Hermione bails him out of trouble by loaning him $\mathrm{}318$.
Harry’s loan to Lucius and his loan from Hermione are different from the transactions in his budget because the $\mathrm{}318$ loan and the $\mathrm{}70$ loan both created liabilities for someone. So, let’s keep track of the transactions that created a liability in a separate balance sheet:
Source of funds or use of fundsAmount
Loan to Lucius$-\mathrm{}70$ (it is negative because this money left his possession)
Loan from Hermione$+\mathrm{}318$ (it is positive because this money came into his possession)
Harry’s budget is his current account that summarizes all transactions that have not created liabilities. The transactions that created liabilities are his capital and financial account because those I.O.U. ’s eventually will need to be repaid.
We can summarize these in the table below:
Source of funds or use of fundsAmount
Income earned from selling copies of his book “Talking to snakes for fun and profit”$+\mathrm{}1000$
Income earned from owl consultancy services$+\mathrm{}200$
Money spent on dementor repellant$-\mathrm{}1200$
Money spent paying for investment advice$-\mathrm{}300$
Wand rent$+\mathrm{}50$
Allowance from Aunt Petunia:$+\mathrm{}2$
Harry’s current account balance$\mathrm{}1000+\mathrm{}200+\mathrm{}50+\mathrm{}2-1200-\mathrm{}300=-\mathrm{}248$
Outflow of money loaned$-\mathrm{}70$
Inflow of money borrowed from Hermione$\mathrm{}318$
Harry’s Capital and Financial Account balance$\mathrm{}-70+\mathrm{}+318=\mathrm{}+248$
We can relate a country’s balance of payments account to the scenario we described above. The table below shows entries for the nation of Panem that are comparable to each of the entries on Harry’s Balance sheet:
Harry's source of funds or use of fundsHarry's AmountPanem's amount (in billions)Panem's category of BOP
Income earned from selling copies of his book “Talking to snakes for fun and profit”$+\mathrm{}1000$$+\mathrm{}1000$Goods exports
Money spent on dementor repellant$-\mathrm{}1200$$-\mathrm{}1200$Goods imports
Balance on goods$\begin{array}{rl}& \mathrm{}1000-\mathrm{}1200\\ \\ & =-\mathrm{}200\end{array}$$\begin{array}{rl}& \mathrm{}1000-\mathrm{}1200\\ \\ & =-\mathrm{}200\end{array}$Balance on goods
Money spent paying for investment advice$-\mathrm{}300$$-\mathrm{}300$Service imports
Income earned from owl consultancy services$+\mathrm{}200$$+\mathrm{}200$Service exports
Balance on services$\begin{array}{rl}& -\mathrm{}300+\mathrm{}200\\ \\ & =-\mathrm{}100\end{array}$$\begin{array}{rl}& -\mathrm{}300+\mathrm{}200\\ \\ & =-\mathrm{}100\end{array}$Balance on services
Wand rent$+\mathrm{}50$$+\mathrm{}50$Net investment income (also called factor income)
Allowance from Aunt Petunia$+\mathrm{}2$$+\mathrm{}2$Transfers and remittances
Harry’s current account balance$\begin{array}{rl}\left(-& \mathrm{}200\right)\\ \\ +\left(-& \mathrm{}100\right)\\ \\ +& \mathrm{}50\\ \\ +& \mathrm{}2\\ \\ =\left(-& \mathrm{}248\right)\end{array}$$\begin{array}{rl}\left(-& \mathrm{}200\right)\\ \\ +\left(-& \mathrm{}100\right)\\ \\ +& \mathrm{}50\\ \\ +& \mathrm{}2\\ \\ =\left(-& \mathrm{}248\right)\end{array}$Panem’s current account balance
Outflow of money loaned$-\mathrm{}70$$-\mathrm{}70$Outflow of foreign assets from Panem
Inflow of money borrowed from Hermione$\mathrm{}318$$+\mathrm{}318$Inflow of foreign assets to Panem
Harry's capital and financial account balance$\begin{array}{rl}-& \mathrm{}70\\ \\ +& \mathrm{}318\\ \\ =& \mathrm{}248\end{array}$$\begin{array}{rl}-& \mathrm{}70\\ \\ +& \mathrm{}318\\ \\ =& \mathrm{}248\end{array}$Panem’s capital and financial account balance
Balance of payments$\begin{array}{rl}& CA+CFA\\ \\ & =-\mathrm{}248+\mathrm{}248\\ \\ & =\mathrm{}0\end{array}$$\begin{array}{rl}& CA+CFA\\ \\ & =-\mathrm{}248+\mathrm{}248\\ \\ & =\mathrm{}0\end{array}$Balance of payments

Want to join the conversation?

• This question might be rather stupid but how do we account for transactions that are made with previously saved money? Meaning we don't get the money to transact (current account) from a loan (capital account) but from money we already have?
• If Harry used up $318 of his own wealth instead of borrowing it, then there will be a transfer of money from Harry to other people. But money is a financial asset! So this is a transfer of a financial asset from a country (Harry) to another country (everyone else), which increases the capital account. (3 votes) • How does a surplus in Financial Accts help offset a current account deficit? Since, a surplus in Financial Accts means you took out loans that you have to repay later, doesn't that just increase our overall deficit in the long run? (4 votes) • This is very much like accounting. Wow. (2 votes) • no question (1 vote) • can we have a trade deficit balance despite surplus current account balance? (1 vote) • yes it is quite possible. suppose a poor county has to import more than export (trade deficit) by$100m. It recieves foriegn aid by US of $200m .Assuming the country has 0 net investment incomr the current account will have a surplus of$100m.
(1 vote)
• what does CFA stand for?
(1 vote)
• Capital Financial Account
(1 vote)
• If an asset is paid off, like say rent is given, that would fall in current account right but then why would it need to be again repaid
What i mean is that Hermione helped Harry by giving him money but what do countries do
or lets rephrase
do countries have to work to balance the accounts or does it happen automatically