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The Monetary Method And The Size Of The Shadow Economy: A Critical Assessment

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  • Hildegart Ahumada
  • Facundo Alvaredo
  • Alfredo Canavese

Abstract

A widely applied approach to measure the size of the shadow economy, known as the "monetary method" or the "currency approach," is based on econometric estimates of the demand for money. These estimates are used to get the currency held by economic agents in excess of the amount they need to finance registered transactions. This excess of currency multiplied by the income-velocity of circulation (assumed to be equal in the registered and shadow economies) gives a measure of the hidden GDP. This paper shows that the monetary method only produces coherent estimates if the income-elasticity of the demand for currency is one and suggests a way to correct the estimated size of the shadow economy when such elasticity is not one. The correction is applied to existent measures for different countries. Copyright 2007 The Authors; Journal compilation International Association for Research in Income and Wealth 2007.

Suggested Citation

  • Hildegart Ahumada & Facundo Alvaredo & Alfredo Canavese, 2007. "The Monetary Method And The Size Of The Shadow Economy: A Critical Assessment," Review of Income and Wealth, International Association for Research in Income and Wealth, vol. 53(2), pages 363-371, June.
  • Handle: RePEc:bla:revinw:v:53:y:2007:i:2:p:363-371
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