IDEAS home Printed from https://ideas.repec.org/a/bpj/bejmac/v25y2025i2p951-978n1011.html

Firm Dynamics, Informality, and Monetary Policy

Author

Listed:
  • Yépez Carlos A.

    (Department of Economics, University of Manitoba, Rm. 644 Fletcher Argue Bldg., R3T 5V5, Winnipeg, MB, Canada)

Abstract

A prominent structural feature of many developing countries is the presence of a large shadow or informal economy, which often serves as a form of insurance during economic downturns. Despite this understanding, the impact of the informal economy on inflation and output dynamics in these countries remains poorly understood. This study investigates the extent to which monetary policy can stabilize economies with a large informal market. First, we use VAR analysis to provide new evidence indicating that the labor informality rate increases in response to contractionary monetary policy. Second, we explore the transmission mechanism of monetary policy through a two-sector New Keynesian (NK) model that incorporates endogenous firm entry. This analysis allows us to examine the role of informality in sectoral reallocation, inflation, and output dynamics. Our findings suggest that, under a reasonable calibration of the model, the presence of a flexible, informal sector results in a lower sacrifice ratio in response to a tightening of monetary policy. This suggests that informality enhances the effectiveness of monetary policy.

Suggested Citation

  • Yépez Carlos A., 2025. "Firm Dynamics, Informality, and Monetary Policy," The B.E. Journal of Macroeconomics, De Gruyter, vol. 25(2), pages 951-978.
    • Handle: RePEc:bpj:bejmac:v:25:y:2025:i:2:p:951-978:n:1011
    DOI: 10.1515/bejm-2025-0024
    as

    Download full text from publisher

    File URL: https://doi.org/10.1515/bejm-2025-0024
    Download Restriction: For access to full text, subscription to the journal or payment for the individual article is required.
    File URL: https://libkey.io/10.1515/bejm-2025-0024?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    As the access to this document is restricted, you may want to

    for a different version of it.

    More about this item

    Keywords

    ;
    ;
    ;
    ;
    ;
    ;

    JEL classification:

    • E23 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Production
    • E26 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Informal Economy; Underground Economy
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • O17 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Formal and Informal Sectors; Shadow Economy; Institutional Arrangements

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:bpj:bejmac:v:25:y:2025:i:2:p:951-978:n:1011. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    We have no bibliographic references for this item. You can help adding them by using this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Peter Golla (email available below). General contact details of provider: https://www.degruyterbrill.com .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.