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The informal economy and business cycles

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Abstract

A vast literature has focused on what causes businesses to move into informality and what is the impact of an enlarging informal sector on growth. This paper shows that the size of the informal economy also affects business cycle volatility. Informal businesses are usually small in size, which not only prevents them from achieving economies of scale and from operating with the right capital/labor mix, but also restricts their access to credit markets. Because firms operating informally lack access to credit markets to neutralize the cash flow squeeze arising during recessions, they are more exposed to fluctuations in economic activity and more likely to fail. Using a Generalized Method of Moments methodology, this paper shows that countries with larger informal economies tend to undergo increased volatility in output, investment and consumption over the business cycle.

Suggested Citation

  • Gisele Ferreira-Tiryaki, 2008. "The informal economy and business cycles," Journal of Applied Economics, Universidad del CEMA, vol. 11, pages 91-117, May.
  • Handle: RePEc:cem:jaecon:v:11:y:2008:n:1:p:91-117
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    File URL: http://www4.cema.edu.ar/pjae/m/164FerreiraTiry200805
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    Citations

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    Cited by:

    1. Catalina Granda Carvajal, 2015. "Informality and macroeconomic volatility: do credit constraints matter?," Journal of Economic Studies, Emerald Group Publishing, vol. 42(6), pages 1095-1111, November.
    2. Catalina Granda-Carvajal, 2012. "Macroeconomic Implications of the Underground Sector: Challenging the Double Business Cycle Approach," Economic Analysis and Policy, Elsevier, vol. 42(2), pages 237-256, September.
    3. Roberto Dell’Anno, 2010. "Institutions and human development in the Latin American informal economy," Constitutional Political Economy, Springer, vol. 21(3), pages 207-230, September.
    4. Giuseppe Ciccarone & Francesco Giuli & Enrico Marchetti, 2016. "Search frictions and labor market dynamics in a real business cycle model with undeclared work," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 62(3), pages 409-442, August.

    More about this item

    Keywords

    business cycles; informal sector; legal institutions;

    JEL classification:

    • E26 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Informal Economy; Underground Economy
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles

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