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Inflation Dynamics in the Presence of Informal Labour Markets

  • Paul Castillo B.
  • Carlos Montoro Ll.

We analyze the effects of informal labor markets on the dynamics of inflation and on the transmission of aggregate demand and supply shocks. In doing so, we incorporate the informal sector in a modified New Keynesian model with labor market frictions as in the Diamond-Mortensen-Pissarides model. Our main results show that the informal economy generates a "buffer" effect that diminishes the pressure of demand shocks on inflation. Finding that is consistent with the empirical literature on the effects of informal labor markets in business cycle fluctuations. This result implies that in economies with large informal labor markets the interest rate channel of monetary policy is relatively weaker. Furthermore, the model produces cyclical flows from informal to formal employment consistent with the data.

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File URL: http://www.bcentral.cl/eng/studies/economia-chilena/2012/apr/recv15n1abr2012pp4-31.pdf
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Article provided by Central Bank of Chile in its journal Economía Chilena.

Volume (Year): 15 (2012)
Issue (Month): 1 (April)
Pages: 4-31

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Handle: RePEc:chb:bcchec:v:15:y:2012:i:1:p:4-31
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  1. Mariano Bosch, 2006. "Job creation and job destruction in the presence of informal labour markets," LSE Research Online Documents on Economics 19785, London School of Economics and Political Science, LSE Library.
  2. Thomas Lubik & Michael Krause, 2003. "The (Ir)relevance of Real Wage Rigidity in the New Keynesian Model with Search Frictions," Economics Working Paper Archive 504, The Johns Hopkins University,Department of Economics.
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  7. Thomas, Carlos, 2008. "Search and matching frictions and optimal monetary policy," Journal of Monetary Economics, Elsevier, vol. 55(5), pages 936-956, July.
  8. Pierpaolo Benigno & Michael Woodford, 2005. "Inflation Stabilization And Welfare: The Case Of A Distorted Steady State," Journal of the European Economic Association, MIT Press, vol. 3(6), pages 1185-1236, December.
  9. Maurizio Bovi, 2007. "Shadow Employment and Labor Productivity Dynamics," LABOUR, CEIS, vol. 21(4-5), pages 735-761, December.
  10. Blanchard, Olivier J & Galí, Jordi, 2008. "Labour Markets and Monetary Policy: A New Keynesian Model with Unemployment," CEPR Discussion Papers 6765, C.E.P.R. Discussion Papers.
  11. Trigari, Antonella, 2004. "Equilibrium unemployment, job flows and inflation dynamics," Working Paper Series 0304, European Central Bank.
  12. Batini, Nicoletta & Kim, Young-Bae & Levine, Paul & Lotti, Emanuela, 2011. "Informal Labour and Credit Markets: A Survey," Working Papers 11/94, National Institute of Public Finance and Policy.
  13. Carillo, Maria Rosaria & Pugno, Maurizio, 2004. "The underground economy and underdevelopment," Economic Systems, Elsevier, vol. 28(3), pages 257-279, September.
  14. Kolm, Ann-Sofie & Larsen, Birthe, 2006. "Does Tax Evasion Affect Unemployment and Educational Choice?," Working Papers 12-2003, Copenhagen Business School, Department of Economics.
  15. Christopher A. Pissarides, 2000. "Equilibrium Unemployment Theory, 2nd Edition," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262161877, June.
  16. Cheron, Arnaud & Langot, Francois, 2000. "The Phillips and Beveridge curves revisited," Economics Letters, Elsevier, vol. 69(3), pages 371-376, December.
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