SHOE LEATHER COSTS

As we have discussed, inflation is like a tax on the hiders of money. The tax itself is not a cost to society:It is only a transfer of resources from households to the government. Yet most taxes give people an incentive to alter their behavior to avoid paying the tax, and this distortion of incentives causes dead weight losses for society as a whole. Like other axes, the inflation tax also causes dead weight losses because people waste scarce resources trying to avoid it.

How can a person avoid paying the inflation tax? Because inflation erodes the real value of the money in your wallet, you can avoid the inflation tax by holding less money. One way to do this is to go to the bank more often. For example, rather than withdrawing $200 every four weeks, you might withdraw $50 once a week. By making more frequent trips to the bank, you can keep more of your wealth in your interest-bearing savings account and less in your wallet, where inflation erodes its value.

The cost of reducing your money holdings is called the shoe leather cost of inflation because making more frequent trips to the bank causes your shoes to wear out more quickly. Of course, this term is not to be taken literally: The actual cost of reducing your money holdings is not the wear and tear on your shoes but the time and convenience you must sacrifice to keep ,money on hand than you would if there were no inflation.

The shoe leather costs of inflation may seem. And in fact, they are in the IT.S. economy, which has had only moderate inflation in recent years. But this cost is magnified in countries experiencing hyperinflation is a description of one person’s experience in Bolivia during its hyperinflation(as reported in the August 13, 1985, issue of The Wall Street Journal .

When Edgar Miranda gets his monthly teacher’s pay of 25 million pesos, he hasn’t a moment to lose. Every hour, pesos drop in value. So, while his wife rushes to market to lay in a month’s supply of rice and noodles, he is off with the rest of the pesos to change them into black-market dollars.

Mr. Miranda is practicing the First Rule of Survival amid the most out-of-control inflation in the world today. Bolivia is a case study of how runaway inflation undermines a society. Price increases are so huge that the figures build up almost beyond “comprehension, In one six-month period, for example, prices soared at an annual rate of 38,000 percent. By official count, however, last year’s inflation reached 2,000 percent, and this year’s is expected to hit 8,000 percent-though other estimates range many times higher. In any rewrite, Bolivia’s rate dwarfs Israel’s 370 percent and Argentina’s 1,100 percent-two other cases of severe inflation .

It is easier to comprehend what happens to the thirty eight year old Mr. Miranda’s pay if he doesn’t quickly change it into dollars. {he day he was paid 25 million pesos, a dollar cost 500,000 pesos. So he received $50. Just days later, with the rate at 900,000 pesos, he would have received .

As this story shows, the shoe leather costs of inflation can be substantial. With the high inflation rate, Mr.Miranda does not have the luxury of holding the local money as a store of value. Instead,  he is forced to convert his pesos quickly into goods or into U.S. dollars, which offer a more stable store of value. The time and effort that Mr. Miranda expends to reduce his money holdings are a waste of resources. If the monetary  authority pursued a low-inflation policy, Mr. Miranda would be happy to hold pesos, and lie could put his time and effort to more productive use. In fact, shortly after this article was written, the Bolivian inflation rate was reduced substantially with more restrictive monetary policy.