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.

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Macroeconomics

Course: Macroeconomics > Unit 6

Lesson 1: The balance of payments

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

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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 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	$\begin{aligned}&\$1000-\$1200\\\\&=-\$200\end{aligned}$	$\begin{aligned}&\$1000-\$1200\\\\&=-\$200\end{aligned}$	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	$\begin{aligned}&-\$300+\$200\\\\&=-\$100\end{aligned}$	$\begin{aligned}&-\$300+\$200\\\\&=-\$100\end{aligned}$	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	$\begin{aligned}(-&\$200)\\\\ + (-&\$100)\\\\ +&\$50\\\\+ &\$2\\\\=(-&\$248)\end{aligned}$	$\begin{aligned}(-&\$200)\\\\ + (-&\$100)\\\\ +&\$50\\\\+ &\$2\\\\=(-&\$248)\end{aligned}$	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	$\begin{aligned}-&\$70 \\\\+ &\$318\\\\=&\$248\end{aligned}$	$\begin{aligned}-&\$70 \\\\+ &\$318\\\\=&\$248\end{aligned}$	Panem’s capital and financial account balance
Balance of payments	$\begin{aligned} &CA+CFA\\\\& =-\$248 + \$248\\\\&=\$0\end{aligned}$	$\begin{aligned} &CA+CFA\\\\& =\small -\$248 + \$248\\\\&=\$0\end{aligned}$	Balance of payments

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Mischa Riedo
Posted 5 years ago. Direct link to Mischa Riedo's post “This question might be ra...”
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?
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- Tony Zheng
  Posted 3 years ago. Direct link to Tony Zheng's post “If Harry used up $318 of ...”
  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.
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  (2 votes)
P A
Posted 3 years ago. Direct link to P A's post “How does a surplus in Fin...”
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?
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Billie Patterson
Posted 3 months ago. Direct link to Billie Patterson's post “This is very much like ac...”
This is very much like accounting. Wow.
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Tracy,C
Posted 10 months ago. Direct link to Tracy,C's post “no question”
no question
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royshreshtha1997
Posted 3 years ago. Direct link to royshreshtha1997's post “can we have a trade defic...”
can we have a trade deficit balance despite surplus current account balance?
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- hardiksainidelhi
  Posted 4 months ago. Direct link to hardiksainidelhi's post “yes it is quite possible....”
  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.
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idobel
Posted 3 months ago. Direct link to idobel's post “what does CFA stand for?”
what does CFA stand for?
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Anusree Chakraborty
Posted 3 years ago. Direct link to Anusree Chakraborty's post “If an asset is paid off, ...”
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
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Katie E Miller
Posted 4 years ago. Direct link to Katie E Miller's post “so sal was on a harry pot...”
so sal was on a harry potter kick good to know little bro might be happier than me because i am not that big of a potterhead i know a little dit were as my little bro is a big time potterhead
side note wouldn't be in pounds not dollars everyone in the harry potter series english like from england becuase she as hell dont sound american they have a english accsent and considering they are kids they would have to pick it from there friend or parents
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