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Macroeconomic volatility: The role of the informal economy

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  • Restrepo-Echavarria, Paulina

Abstract

Many countries have a large informal economy that is poorly measured in the national accounts. I develop a two-sector small open economy business cycle model where one sector is formal and the other is informal, and explore the effect that the informal sector has on measured business cycles. I show that if the informal economy is poorly measured, the model can generate a volatility of measured consumption that is higher than that of output, as observed in many developing countries and some developed countries, even though actual consumption is not nearly as volatile. My results illustrate the importance of the informal sector and its mis-measurement in understanding measured cyclical fluctuations.

Suggested Citation

  • Restrepo-Echavarria, Paulina, 2014. "Macroeconomic volatility: The role of the informal economy," European Economic Review, Elsevier, vol. 70(C), pages 454-469.
  • Handle: RePEc:eee:eecrev:v:70:y:2014:i:c:p:454-469
    DOI: 10.1016/j.euroecorev.2014.06.012
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    More about this item

    Keywords

    Informal economy; Business cycles; Relative volatility; Mis-measurement; Calibration;
    All these keywords.

    JEL classification:

    • E26 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Informal Economy; Underground Economy
    • E01 - Macroeconomics and Monetary Economics - - General - - - Measurement and Data on National Income and Product Accounts and Wealth; Environmental Accounts
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E41 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Demand for Money

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