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Money, inflation, and unemployment in the presence of informality

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  • Mohammed Aït Lahcen

Abstract

This paper studies the impact of informality on the long-run relationship between inflation and unemployment in developing economies. I present a dynamic general equilibrium model with informality in both labor and goods markets and where money and credit coexist. An increase in inflation affects unemployment through two channels: the matching channel and the hiring channel. On one hand, higher inflation reduces the surplus of monetary trades thus lowering firms entry and increasing unemployment. On the other hand, the lower impact of inflation on formal transactions where credit is partially available shifts firms hiring decision from high separation informal jobs to low separation formal jobs thus reducing unemployment. The model is calibrated to match certain long-run statistics of the Brazilian economy. Numerical results indicate that, in the presence of a sizable informal sector, inflation has a small negative effect on unemployment while producing a significant impact on labor allocation between formal and informal jobs. These results point to the importance of accounting for informality when considering the inflation-unemployment trade-off in the conduct of monetary policy.

Suggested Citation

  • Mohammed Aït Lahcen, 2017. "Money, inflation, and unemployment in the presence of informality," ECON - Working Papers 248, Department of Economics - University of Zurich.
  • Handle: RePEc:zur:econwp:248
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    File URL: http://www.econ.uzh.ch/static/wp/econwp248.pdf
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    More about this item

    Keywords

    Informality; Phillips curve; money; labor; search and matching;

    JEL classification:

    • E26 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Informal Economy; Underground Economy
    • E41 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Demand for Money
    • J64 - Labor and Demographic Economics - - Mobility, Unemployment, Vacancies, and Immigrant Workers - - - Unemployment: Models, Duration, Incidence, and Job Search
    • 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

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