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Money Multiplier Bias Due to Informal Sector: An Extension of the Existing Money Multiplier

Author

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  • Khurrum S. Mughal
  • Friedrich G. Schneider
  • Faheem Aslam
  • Alishba Tahir

Abstract

To demonstrate the impact of informal economy on the official money multiplier in currency supply, we present an extension of the basic money multiplier model. The influence of economic policies may differ if they are based only on official statistics without considering the informal sector. Since most of the activities in informal sector are hidden from authorities, it is widely assumed that these activities are based on cash transactions, a part of total currency that cannot be attracted towards deposits due to the holder’s fear of prosecution and taxation, etc. Therefore, it is expected that such currency holdings can give biased results by playing a role in the money multiplier, a phenomenon that is usually ignored while attempting to alter money supply. The article also indicates that because of informal sector, the currency deposit ratio in the money multiplier is smaller than expected (depending on size of the informal sector), leading to a larger multiplier effect. JEL Classifications: E26, E51, O17

Suggested Citation

  • Khurrum S. Mughal & Friedrich G. Schneider & Faheem Aslam & Alishba Tahir, 2021. "Money Multiplier Bias Due to Informal Sector: An Extension of the Existing Money Multiplier," South Asian Journal of Macroeconomics and Public Finance, , vol. 10(2), pages 139-157, December.
    • Handle: RePEc:sae:smppub:v:10:y:2021:i:2:p:139-157
    DOI: 10.1177/2277978720979888
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    References listed on IDEAS

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    More about this item

    Keywords

    Informal economy; shadow economy; money multiplier;
    All these keywords.

    JEL classification:

    • E26 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Informal Economy; Underground Economy
    • E51 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Money Supply; Credit; Money Multipliers
    • O17 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Formal and Informal Sectors; Shadow Economy; Institutional Arrangements

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