Lucas has recently suggested that the`shoe-leather' costs of in¯ation 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 over the period 1870±1994. We ®nd support for Lucas' proposition -that interest rates should be speci®ed in logs -as a description of money demand dynamics, but not as a steady-state characterisation. Although Lucas' estimates can be corroborated, a semilog interest rate speci®cation 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.Capturing the welfare costs of in¯ation has, on the whole, proved an elusive task for economists. But perhaps the area of least uncertainty surrounds the socalled`shoe-leather' costs of in¯ation -the increased time and cost of making trips to the bank to replenish money balances whenever in¯ation increases. Since Bailey (1956), it has been customary to measure these`shoe-leather' costs as the trapezoid of unsatis®ed demand beneath a money demand schedule, which is foregone at any non-zero nominal interest rate. There is also a common perception that, so-measured, shoe-leather costs are relatively trivial in macroeconomic terms.Certainly, such a conclusion seems robust at the levels of in¯ation currently prevailing within developed economies. For example, Fischer (1981) and McCallum (1989) both estimate that the shoe-leather bene®t from a 10% point reduction in in¯ation is around 0.3% of GNP. But in today's low-in¯ation environment, a reduction in in¯ation of around 2% points seems more apposite. Using the above calculus, such a reduction would deliver a welfare gain of only around 0.06% of GNP -a small number by most people's reckoning. Indeed, a recent study by Feldstein (1995) concludes that the shoeleather savings from a move from 2% to zero in¯ation could well be negative once the indirect effect on seigniorage revenues is taken into account -a point ®rst raised by Phelps (1973). 1 That academic view chimes with anecdotal evidence. A recent survey by Shiller (1996) posed the question`Why do people dislike in¯ation?' Among the general public, there was no mention of the extra time and cost expended by agents replenishing their money balances at high rates of in¯ation. There was, as you might expect, a greater recognition of these costs among econothe comments of two anonymous referees helped materially improve the paper. Martin Cleaves, Bruce Devile, Siobhan Phillips and Jenny Salvage provided valuable research assistance. Of course, any remaining errors and omissions are ours. The views expressed within are not necessarily those of the Bank of England.1 Feldstein (1995) ®nds much larger distortions from in¯ation arising from the imperfect indexation of the United States tax system -amounting perhaps to as much as 1% of GNP in perpetuity. That leads him to argue strongly for a zero in¯ation target.

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Following Hall (Journal of Labor Economics, Vol. 15 (1997), pp. S223–S250) it is increasingly common to incorporate preference, as well as productivity, perturbations in calibrated general equilibrium models. We assess the performance of a small open economy stochastic growth model (based on the Blanchard–Yaari framework) under alternative driving processes. Whilst both models provide familiar descriptions of the aggregate economy, we find that the model driven by productivity disturbances has clear advantages in explaining the behaviour towards foreign asset accumulation.

This paper constructs a consistent series for the market value of UK government debt over almost 300 years, analysing how monetary and fiscal policy affect the path of the UK price level. Specifically, it examines the interactions between debts, deficits, the monetary base and the price level. Overall, the price level has been closely related to the evolution of the base money supply. Across different sample periods, there is little econometric evidence that fiscal policy has affected the course of the price level (or of the exchange rate under the Gold Standard). Government debt has not significantly affected the base money stock, either.

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