Considering Labor Informality in Forecasting Poverty and Inequality: A Microsimulation Modelfor Latin American and Caribbean Countries

Economists have long been interested in measuring the poverty and distributional impacts ofmacroeconomic projections and shocks. In this sense, microsimulation models have been widely used to estimate thedistributional effects since they allow accounting for several transmission channels through which macroeconomicforecasts could impact individuals and households. This paper innovates previous microsimulation methodology byintroducing more flexibility in labor earnings, considering intra-sectoral variation according to the formality status,and assessing its effect on forecasting country-level poverty, inequality, and other distributive indicators. Theresults indicate that the proposed methodology accurately estimates the intensity of poverty in the most immediateyears indistinctively of how labor income is simulated. However, allowing for more intra-sectoral variation in laborincome leads to more accurate projections in poverty and across the income distribution, with gains in performance inthe middle term, especially in atypical years such as 2020.