Four Ways to Pay

Representing Payment Types

Payment mechanics can be counterintuitive. One reason is that there are more ways to pay than just handing someone money.

Borja Clavero (2021, 17:30) quotes Wadsley and Penn (2000):

It is not always clear from the way we talk which party is paying whom ... No doubt the confusion arises because concepts appropriate to the simple payment in cash [...] are stretched to make them apply to the more complex world of modern payment mechanisms.
(Wadsley and Penn 2000, 366)

In the Money and Banking course, Mehrling (2012) often represents payments by adding and subtracting balance-sheet assets and liabilities. A big part of the course is learning how to read balance-sheet operations. If you can read balance sheets, it will always be clear who's paying whom.

Consider the aforementioned simple case of paying someone by handing them money.

We can read the rows on this set of balance sheets chronologically from top to bottom.

1. The top row shows the initial state in which the payor holds money as an asset.

2. The middle row shows the payment operation in which money is subtracted from the payor's balance sheet and added to that of the payee.

3. The bottom row shows the final state in which the payee has the money.

Borja Clavero (2021, 2022) calls this payment by assignment. The owner of the money passes it to someone else. Assignment is only the first of four payment types.

Following Clavero (2021), I will highlight assignment in yellow.

The second type of payment is payment by issuance. This means paying someone now by promising to pay them later—that is, paying on credit. I pay you by issuing an IOU for money. That IOU is my liability and your asset.

I will highlight issuance in green.

In the above balance sheets, nobody starts with money or any other assets. Nevertheless, a payment has been made.

The third type of payment is payment by set-off. That means I pay you by canceling a debt that you owe me. The IOU—my asset and your liability—is extinguished. Set-off is the mirror image of issuance.

I will highlight set-off in red.

The final payment type is payment by novation. I pay you by taking on one of your debts.

I will highlight novation in blue.

Clip Length 1:20 (Clavero 2021, 23:39–24:59)

That there are four ways of making a payment is not subject to discussion, alright? Because that would be going against logic. Logic determines this. There is no way around it.
(Clavero 2021, 24:20)

Here are all four payment types together.

To emphasize the direction of payments, we can use a color-coded arrow notation that I've adapted from Chris Rimmer (2021).

The early lectures of the course (Mehrling 2012) cover the payments system. An intuition for the four payment types will help us get the most out of those lectures.

References

Clavero, Borja. 2021. "Money and Hierarchy: Four Ways to Discharge a Payment Obligation," Segment 16:31–35:05 of "Applying the Money View | Presentations IV." Money View Symposium, INET Young Scholars Initiative, recorded March 6, 2021. Video, 1:23:49. https://youtu.be/pMC4joNiiPo

Clavero, Borja. 2022. "Money and Hierarchy: Four Ways to Discharge a Payment Obligation." SSRN Scholarly Paper ID 4032398. Social Science Research Network. https://doi.org/10.2139/ssrn.4032398.

Mehrling, Perry. 2012. Economics of Money and Banking. Online course. Coursera. Accessed 2015–2025. https://www.coursera.org/learn/money-banking

Rimmer, Chris. 2021. "A Pictorial Notation to Illustrate Balance Sheet Changes" https://www2.bluehydra.co.uk/misc/notation.pdf

Wadsley, Joan, and G.A. Penn. 2000. The Law and Practice of Domestic Banking. 2nd ed. London: Sweet & Maxwell.