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November/December 1998, 
Vol. 80, No. 6
Posted 1998-11-01

Shoe-Leather Costs of Inflation and Policy Credibility

by Michael R. Pakko

Inflation can cause costly misallocation of resources as consumers seek to protect the purchasing power of their nominal assets. The author 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 author 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.