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Welfare costs of inflation and the circulation of US currency abroad

  • Calza, Alessandro
  • Zaghini, Andrea

Empirical studies of the "shoe-leather" costs of inflation are typically computed using M1 as a measure of money. Yet, official data on M1 includes all currency issued, regardless of the country of residence of the holder. Using monetary data adjusted for US dollars abroad, we show that the failure to control for currency held by non residents may lead to significantly overestimating the shoe-leather costs for the domestic economy. In particular, our estimates of shoe-leather costs are minimized for a positive but moderate value of the inflation rate, thereby justifying a deviation from the Friedman rule in favour of the Fed's current policy. JEL Classification: E31, E41, E52

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Paper provided by European Central Bank in its series Working Paper Series with number 1326.

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Date of creation: Apr 2011
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Handle: RePEc:ecb:ecbwps:20111326
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