Answer to Question 1
In short, the factors that will determine the optimal inflation rate are the relative magnitudes of the costs and benefits of inflation. Therefore, on the cost side, individuals would consider: shoe-leather costs, tax distortions, money illusion, and inflation variability. On the benefit side, one would consider: seignorage, the option of a negative real interest rate, and money illusion. So, an individual would compare the costs and benefits of inflation and choose some optimal inflation rate.
Answer to Question 2
In the medium run, an increase in inflation will cause an increase in nominal interest rates. When the nominal interest rate rises, the opportunity cost of holding money increases causing individuals to reduce their money balances. Individuals, therefore, make more trips to the bank. The costs associated with this are called shoe-leather costs.
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