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Currency demand and MIMIC models: towards a structured hybrid method of measuring the shadow economy

Author

Listed:
  • Piotr Dybka

    (Warsaw School of Economics)

  • Michał Kowalczuk

    (EY Economic Analysis Team)

  • Bartosz Olesiński

    (EY Economic Analysis Team)

  • Andrzej Torój

    (Warsaw School of Economics)

  • Marek Rozkrut

    (EY Economic Analysis Team)

Abstract

Model-based econometric techniques of the shadow economy estimation have been increasingly popular, but a systematic approach to getting the best of their complementarities has so far been missing. We review the dominant approaches in the literature—currency demand analysis and MIMIC model—and propose a hybrid procedure that addresses their previous critique, in particular the misspecification issues in CDA equations and the vague transformation of the latent variable obtained via MIMIC model into interpretable levels and paths of the shadow economy. We propose a new identification scheme for the MIMIC model, referred to as ‘reverse standarization’. It supplies the MIMIC model with the panel-structured information on the latent variable’s mean and variance obtained from the CDA estimates, treating this information as given in the restricted full information maximum likelihood function. This approach allows avoiding some controversial steps, such as choosing an externally estimated reference point for benchmarking or adopting other ad hoc identifying assumptions. We estimate the shadow economy for up to 43 countries, with the results obtained in the range of 2.8–29.9% of GDP. Various versions of our models remain robust as regards changes in the level of the shadow economy over time and the relative position of the analysed countries. We also find that the contribution of (a correctly specified) MIMIC model to the measurement of trends in the shadow economy is marginal as compared to the contribution of the CDA model, confirming the scepticism of some previous literature towards this method.

Suggested Citation

  • Piotr Dybka & Michał Kowalczuk & Bartosz Olesiński & Andrzej Torój & Marek Rozkrut, 2019. "Currency demand and MIMIC models: towards a structured hybrid method of measuring the shadow economy," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 26(1), pages 4-40, February.
  • Handle: RePEc:kap:itaxpf:v:26:y:2019:i:1:d:10.1007_s10797-018-9504-5
    DOI: 10.1007/s10797-018-9504-5
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    More about this item

    Keywords

    Shadow economy; MIMIC; Currency demand approach; Restricted full information maximum likelihood;
    All these keywords.

    JEL classification:

    • C10 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - General
    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
    • C59 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Other
    • E26 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Informal Economy; Underground Economy
    • H26 - Public Economics - - Taxation, Subsidies, and Revenue - - - Tax Evasion and Avoidance
    • O17 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Formal and Informal Sectors; Shadow Economy; Institutional Arrangements

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