Shoe-leather costs reconsidered

Working papers set out research in progress by our staff, with the aim of encouraging comments and debate.
Published on 23 October 1998

Working paper No. 86
By Jagjit S Chadha, Andrew G Haldane and Norbert G J Janssen

Lucas has recently suggested that the ‘shoe-leather’ costs of inflation may amount to as much as 1% of GNP in the United States when moving to the Friedman optimum. We assess his thesis using empirical evidence for the United Kingdom for the period 1870-1994. We find support for the Lucas proposition that interest rates should be specified in logs as a description of money demand dynamics, but not as a steady-state characterisation. Although Lucas’s estimates can be corroborated, a semi-log interest rate specification implies smaller, though still tangible, welfare gain estimates: for example, 0.22% of GNP in perpetuity when moving from 6% to 2% nominal interest rates.

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