Policy Illusion, Macroeconomic Instability And The Unrecorded Economy
AbstractDuring the decade of the 1970’s the US economy unexpectedly suffered from “stagflation” namely, high unemployment, slowed economic growth and high rates of inflation. During the 1980’s the major macroeconomic problem became high interest rates and massive government deficits. Macroeconomists employed ad hoc supply shocks, rational expectations and natural rate of unemployment theories in an effort to account for these anomalous observed economic events. Our paper puts forth an alternative explanation of these events, namely that they were at least partially the result of the growth of the underground economy during this period. The macroeconomic model developed in the paper demonstrates that when monetary policy is committed to a full employment target, growth of the underground economy will give rise to a continuous stagflation which can only be abetted by the monetary authority shifting to a price stability target. Such a shift took place in October 1979 when the Federal Reserve adopted a price stability target and the fiscal authorities assumed the burden of counter cyclical policy. We show that in the presence of an unrecorded economy, such a policy shift will lead to high interest rates and increasing government deficits. In short, the paper demonstrates how the mere illusion of economic malaise can be translated into the reality of economic chaos. Reference: The Underground Economies: Tax Evasion and Information Distortion. Edgar L. Feige (ed.) Cambridge University Press, 1989.
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Bibliographic InfoPaper provided by EconWPA in its series Macroeconomics with number 0501027.
Length: 29 pages
Date of creation: 20 Jan 2005
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Underground economy; unrecorded income; stagflation; deficits; policy illusion; observer-subjectfeedback; rational expectations; Phillips curve.;
Find related papers by JEL classification:
- E1 - Macroeconomics and Monetary Economics - - General Aggregative Models
- E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles
- E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
- E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook
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- George M. Georgiou, 2007. "Measuring the Size of the Informal Economy: A Critical Review," Working Papers 2007, Central Bank of Cyprus.
- Feige, Edgar L., 1990.
"Defining and estimating underground and informal economies: The new institutional economics approach,"
Elsevier, vol. 18(7), pages 989-1002, July.
- Edgar L. Feige, 2003. "Defining And Estimating Underground And Informal Economies: The New Institional Economics Approach," Development and Comp Systems 0312003, EconWPA.
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