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Shoe-leather costs of inflation and policy credibility

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  • Michael R. Pakko

Abstract

Inflation can cause costly misallocations of resources as consumers seek to protect the purchasing power of their nominal assets. In this article, Michael R. Pakko discusses the nature of these distortions - known as "shoe-leather" costs - in a model where the demand for money is motivated by a "shopping-time" constraint. While the estimates of the shoe-leather costs of long-run inflation (implied by this model) are generally consistent with previous studies, the article goes on to show that the transition between inflation rates can involve dynamics that alter the nature of these welfare effects. Specifically, the benefits of a disinflation policy are mitigated by the gradual adjustment of the economy in response to a lower inflation rate. This transition can be particularly protracted when there is uncertainty about the credibility of the disinflation policy.

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Bibliographic Info

Article provided by Federal Reserve Bank of St. Louis in its journal Review.

Volume (Year): (1998)
Issue (Month): Nov ()
Pages: 37-50

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Handle: RePEc:fip:fedlrv:y:1998:i:nov:p:37-50:n:6

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Keywords: Inflation (Finance);

References

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  1. David Andolfatto & Paul Gomme, 1997. "Monetary Policy Regimes and Beliefs," Cahiers de recherche CREFE / CREFE Working Papers 48, CREFE, Université du Québec à Montréal, revised Apr 2001.
  2. Dotsey, Michael & Ireland, Peter, 1996. "The welfare cost of inflation in general equilibrium," Journal of Monetary Economics, Elsevier, vol. 37(1), pages 29-47, February.
  3. Casey B. Mulligan & Xavier X. Sala-i-Martin & Frederic S. Mishkin & Jonas D. M. Fisher, 1997. "The optimum quantity of money: theory and evidence," Proceedings, Federal Reserve Bank of Cleveland, pages 687-724.
  4. CHARLES T. Carlstrom & WILLIAM T. Gavin, 1993. "Zero Inflation: Transition Costs And Shoe Leather Benefits," Contemporary Economic Policy, Western Economic Association International, vol. 11(1), pages 9-17, 01.
  5. Robert J. Shiller, 1996. "Why Do People Dislike Inflation?," Cowles Foundation Discussion Papers 1115, Cowles Foundation for Research in Economics, Yale University.
  6. Cooley, Thomas F & Hansen, Gary D, 1989. "The Inflation Tax in a Real Business Cycle Model," American Economic Review, American Economic Association, vol. 79(4), pages 733-48, September.
  7. Christopher J. Neely & Christopher J. Waller, 1997. "A Benefit-Cost Analysis Of Disinflation," Contemporary Economic Policy, Western Economic Association International, vol. 15(1), pages 50-64, 01.
  8. James B. Bullard & Steven Russell, 2004. "How costly is sustained low inflation for the U.S. economy?," Review, Federal Reserve Bank of St. Louis, issue May, pages 35-68.
  9. Fischer, Stanley, 1981. "Towards an understanding of the costs of inflation: II," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 15(1), pages 5-41, January.
  10. Martin S. Feldstein, 1997. "The Costs and Benefits of Going from Low Inflation to Price Stability," NBER Chapters, in: Reducing Inflation: Motivation and Strategy, pages 123-166 National Bureau of Economic Research, Inc.
  11. Michael R. Pakko, 1998. "Dynamic shoe-leather costs in a shopping-time model of money," Working Papers 1998-007, Federal Reserve Bank of St. Louis.
  12. Michael Bruno & William Easterly, 1996. "Inflation and growth: in search of a stable relationship," Proceedings, Federal Reserve Bank of St. Louis, issue May, pages 139-146.
  13. King, Robert G. & Plosser, Charles I. & Rebelo, Sergio T., 1988. "Production, growth and business cycles : I. The basic neoclassical model," Journal of Monetary Economics, Elsevier, vol. 21(2-3), pages 195-232.
  14. Imrohoroglu, Ayse, 1992. "The welfare cost of inflation under imperfect insurance," Journal of Economic Dynamics and Control, Elsevier, vol. 16(1), pages 79-91, January.
  15. Karni, Edi, 1974. "The Value of Time and the Demand for Money," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 6(1), pages 45-64, February.
  16. Hamilton, James D, 1989. "A New Approach to the Economic Analysis of Nonstationary Time Series and the Business Cycle," Econometrica, Econometric Society, vol. 57(2), pages 357-84, March.
  17. Lucas, Robert E., 1981. "Discussion of : Stanley Fischer, "towards an understanding of the costs of inflation: II"," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 15(1), pages 43-52, January.
  18. Michael Bruno & William Easterly, 1996. "Inflation and growth: in search of a stable relationship," Review, Federal Reserve Bank of St. Louis, issue May, pages 139-146.
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Citations

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Cited by:
  1. Michael R. Pakko & William T. Gavin & Finn E. Kydland, 2004. "Monetary Policy, Taxes, and the Business Cycle," Computing in Economics and Finance 2004 32, Society for Computational Economics.
  2. Miguel Casares, 2007. "The New Keynesian Model and the Euro Area Business Cycle," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 69(2), pages 209-244, 04.
  3. Bernardino Adão & André C. Silva, 2012. "Welfare costs of inflation with distortionary taxation," Economic Bulletin and Financial Stability Report Articles, Banco de Portugal, Economics and Research Department.

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