Using a person's budget to understand the balance of payments
Posted 2023-03-09 18:06:55
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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” | +$1000$1000dollar sign, 1000 |
| Income earned from owl consultancy services | +$200$200dollar sign, 200 |
| Money spent on dementor repellant | −$1200−$1200minus, dollar sign, 1200 |
| Money spent paying for investment advice | −$300−$300minus, dollar sign, 300 |
| Payment from Ron to borrow Harry’s wand | +$50+$50plus, dollar sign, 50 |
| Allowance from Aunt Petunia | +$2+$2plus, dollar sign, 2 |
| Harry’s balance | −$248−$248minus, 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 $70$70dollar sign, 70. That means he also has a financial asset in the form of an I.O.U. from Lucius, but also $70$70dollar sign, 70 less money available to him. That means Harry has a total shortfall of cash of $248+$70=$318$248+$70=$318dollar sign, 248, plus, dollar sign, 70, equals, dollar sign, 318. As usual, his friend Hermione bails him out of trouble by loaning him $318$318dollar sign, 318.
Harry’s loan to Lucius and his loan from Hermione are different from the transactions in his budget because the $318$318dollar sign, 318 loan and the $70$70dollar 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 | −$70−$70minus, dollar sign, 70 (it is negative because this money left his possession) |
| Loan from Hermione | +$318+$318plus, 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” | +$1000+$1000start color #6495ed, plus, dollar sign, 1000, end color #6495ed |
| Income earned from owl consultancy services | +$200+$200start color #6495ed, plus, dollar sign, 200, end color #6495ed |
| Money spent on dementor repellant | −$1200−$1200start color #6495ed, minus, dollar sign, 1200, end color #6495ed |
| Money spent paying for investment advice | −$300−$300start color #6495ed, minus, dollar sign, 300, end color #6495ed |
| Wand rent | +$50+$50start color #6495ed, plus, dollar sign, 50, end color #6495ed |
| Allowance from Aunt Petunia: | +$2+$2start 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 | −$70−$70start color #ffa500, minus, dollar sign, 70, end color #ffa500 |
| Inflow of money borrowed from Hermione | $318$318start color #ffa500, dollar sign, 318, end color #ffa500 |
| Harry’s Capital and Financial Account balance | $−70+$+318=$+248$−70+$+318=$+248start 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” | +$1000+$1000start color #ffa500, plus, dollar sign, 1000, end color #ffa500 | +$1000+$1000start color #df0030, plus, dollar sign, 1000, end color #df0030 | Goods exports |
| Money spent on dementor repellant | −$1200−$1200start color #ffa500, minus, dollar sign, 1200, end color #ffa500 | −$1200−$1200start color #df0030, minus, dollar sign, 1200, end color #df0030 | Goods imports |
| Balance on goods | $1000−$1200=−$200$1000−$1200=−$200 | $1000−$1200=−$200$1000−$1200=−$200 | Balance on goods |
| Money spent paying for investment advice | −$300−$300start color #ffa500, minus, dollar sign, 300, end color #ffa500 | −$300−$300start color #df0030, minus, dollar sign, 300, end color #df0030 | Service imports |
| Income earned from owl consultancy services | +$200+$200start color #ffa500, plus, dollar sign, 200, end color #ffa500 | +$200+$200start color #df0030, plus, dollar sign, 200, end color #df0030 | Service exports |
| Balance on services | −$300+$200=−$100−$300+$200=−$100 | −$300+$200=−$100−$300+$200=−$100 | Balance on services |
| Wand rent | +$50+$50start color #ffa500, plus, dollar sign, 50, end color #ffa500 | +$50+$50start color #df0030, plus, dollar sign, 50, end color #df0030 | Net investment income (also called factor income) |
| Allowance from Aunt Petunia | +$2+$2start color #ffa500, plus, dollar sign, 2, end color #ffa500 | +$2+$2start 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) | (−$200)+(−$100)+$50+$2=(−$248)(−+(−++=(−$200)$100)$50$2$248) | Panem’s current account balance |
| Outflow of money loaned | −$70−$70start color #6495ed, minus, dollar sign, 70, end color #6495ed | −$70−$70start color #9d38bd, minus, dollar sign, 70, end color #9d38bd | Outflow of foreign assets from Panem |
| Inflow of money borrowed from Hermione | $318$318start color #6495ed, dollar sign, 318, end color #6495ed | +$318+$318start 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 | −$70+$318=$248−+=$70$318$248 | Panem’s capital and financial account balance |
| Balance of payments | ��+���=−$248+$248=$0CA+CFA=−$248+$248=$0 | ��+���=−$248+$248=$0CA+CFA=−$248+$248=$0 | Balance of payments |
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