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 funds Amount
Income earned from selling copies of his book “Talking to snakes for fun and profit” +dollar sign, 1000
Income earned from owl consultancy services +dollar sign, 200
Money spent on dementor repellant minus, dollar sign, 1200
Money spent paying for investment advice minus, dollar sign, 300
Payment from Ron to borrow Harry’s wand plus, dollar sign, 50
Allowance from Aunt Petunia plus, dollar sign, 2
Harry’s balance minus, dollar sign, 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 dollar sign, 70. That means he also has a financial asset in the form of an I.O.U. from Lucius, but also dollar sign, 70 less money available to him. That means Harry has a total shortfall of cash of dollar sign, 248, plus, dollar sign, 70, equals, dollar sign, 318. As usual, his friend Hermione bails him out of trouble by loaning him dollar sign, 318.
Harry’s loan to Lucius and his loan from Hermione are different from the transactions in his budget because the dollar sign, 318 loan and the dollar sign, 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 funds Amount
Loan to Lucius minus, dollar sign, 70 (it is negative because this money left his possession)
Loan from Hermione plus, dollar sign, 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 funds Amount
Income earned from selling copies of his book “Talking to snakes for fun and profit” start color #6495ed, plus, dollar sign, 1000, end color #6495ed
Income earned from owl consultancy services start color #6495ed, plus, dollar sign, 200, end color #6495ed
Money spent on dementor repellant start color #6495ed, minus, dollar sign, 1200, end color #6495ed
Money spent paying for investment advice start color #6495ed, minus, dollar sign, 300, end color #6495ed
Wand rent start color #6495ed, plus, dollar sign, 50, end color #6495ed
Allowance from Aunt Petunia: start color #6495ed, plus, dollar sign, 2, end color #6495ed
Harry’s current account balance $1000+$200+$50+$2−$1200−$300=−$248
Outflow of money loaned start color #ffa500, minus, dollar sign, 70, end color #ffa500
Inflow of money borrowed from Hermione start color #ffa500, dollar sign, 318, end color #ffa500
Harry’s Capital and Financial Account balance start color #ffa500, dollar sign, minus, 70, plus, dollar sign, plus, 318, equals, dollar sign, plus, 248, end color #ffa500
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 funds Harry's Amount Panem's amount (in billions) Panem's category of BOP
Income earned from selling copies of his book “Talking to snakes for fun and profit” start color #ffa500, plus, dollar sign, 1000, end color #ffa500 start color #df0030, plus, dollar sign, 1000, end color #df0030 Goods exports
Money spent on dementor repellant start color #ffa500, minus, dollar sign, 1200, end color #ffa500 start color #df0030, minus, dollar sign, 1200, end color #df0030 Goods imports
Balance on goods $1000−$1200=−$200 $1000−$1200=−$200 Balance on goods
Money spent paying for investment advice start color #ffa500, minus, dollar sign, 300, end color #ffa500 start color #df0030, minus, dollar sign, 300, end color #df0030 Service imports
Income earned from owl consultancy services start color #ffa500, plus, dollar sign, 200, end color #ffa500 start color #df0030, plus, dollar sign, 200, end color #df0030 Service exports
Balance on services −$300+$200=−$100 −$300+$200=−$100 Balance on services
Wand rent start color #ffa500, plus, dollar sign, 50, end color #ffa500 start color #df0030, plus, dollar sign, 50, end color #df0030 Net investment income (also called factor income)
Allowance from Aunt Petunia start color #ffa500, plus, dollar sign, 2, end color #ffa500 start color #df0030, plus, dollar sign, 2, end color #df0030 Transfers and remittances
Harry’s current account balance (−$200)+(−$100)+$50+$2=(−$248) (−$200)+(−$100)+$50+$2=(−$248) Panem’s current account balance
Outflow of money loaned start color #6495ed, minus, dollar sign, 70, end color #6495ed start color #9d38bd, minus, dollar sign, 70, end color #9d38bd Outflow of foreign assets from Panem
Inflow of money borrowed from Hermione start color #6495ed, dollar sign, 318, end color #6495ed start color #9d38bd, plus, dollar sign, 318, end color #9d38bd Inflow of foreign assets to Panem
Harry's capital and financial account balance −$70+$318=$248 −$70+$318=$248 Panem’s capital and financial account balance
Balance of payments ��+���=−$248+$248=$0 ��+���=−$248+$248=$0 Balance of payments