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Shadow economy: Does it matter for money velocity?

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  • Luisanna Onnis
  • Patrizio Tirelli

Abstract

The standard approach adopted in the literature exploits data on money demand to extrapolate the dynamics of the unobserved economic activity. In this paper, we explore instead the long-run effects of shadow economy measures—obtained independently from money demand functions—on the velocity of circulation of money. Empirical evidence from a panel covering 43 countries over the period 1981–2005 shows that variations in the relative size of the unrecorded sector have a negative and significant effect on the velocity of circulation of money. This is because, ceteris paribus, the higher the share of the shadow economy, the higher the demand for currency and therefore the lower the velocity of circulation of money. The negative relation between underground economic activity and velocity of circulation of money is robust to the use of different shadow economy estimates, to a sub-sample analysis and to the inclusion of a time trend. Copyright Springer-Verlag Berlin Heidelberg 2015

Suggested Citation

  • Luisanna Onnis & Patrizio Tirelli, 2015. "Shadow economy: Does it matter for money velocity?," Empirical Economics, Springer, vol. 49(3), pages 839-858, November.
  • Handle: RePEc:spr:empeco:v:49:y:2015:i:3:p:839-858
    DOI: 10.1007/s00181-015-0914-2
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    More about this item

    Keywords

    Money velocity; Money demand; Shadow economy; Informal sector; E41; H26; O17; O5;
    All these keywords.

    JEL classification:

    • E41 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Demand for Money
    • H26 - Public Economics - - Taxation, Subsidies, and Revenue - - - Tax Evasion and Avoidance
    • O17 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Formal and Informal Sectors; Shadow Economy; Institutional Arrangements
    • O5 - Economic Development, Innovation, Technological Change, and Growth - - Economywide Country Studies

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