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.
Shoe-leather costs reconsidered