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Abstract:
This paper studies equilibrium effects of fiscal policy within a dynamic general equilibrium model where tax evasion and underground activities are explicitly incorporated. There are three main results. (i) The underground sector mitigates the distortionary impact of fiscal policies, while lessening the drop (rise) of aggregate production after restrictive (expansionary) tax shifts. In this respect, tax evasion and the informal economy offer a channel for insuring income and consumption from distortions generated by fiscal policy. (ii) Tax evasion and underground economy can completely reverse the theoretical predictions of the standard neoclassical growth model and rationalize expansionary responses to contractionary fiscal policies. (iii) A dynamic general equilibrium with tax evasion gives a rational justification for a variant of the Laffer curve.

Two-sector Dynamic General Equilibrium Models, Fiscal Policy, Tax Evasion

Abstract:
This paper develops a new theoretical framework, introducing into the traditional real business cycle model a second sector, which we interpret as representing the underground economy. We find that a model with an underground sector is quite successful in matching the stylized facts of the business cycle, improving some unsatisfactory results such as the employment volatility puzzle and productivity puzzle. Further, we show that it produces substantial internal propagation of temporary shocks. Then we explain how the underground activity helps to mitigate recessions and the cost of high tax burdens by allowing the household to smooth consumption through a proper labor allocation between the two sectors.

Real business cycle, Underground Economy, Investment Volatility, Taxation

Abstract:
In contrast with well known theoretical and empirical results, this model shows that no externalities, no (even mild) increasing returns, no variable capacity utilization, no variable effort, no consumption habit formation are needed for demand shocks to explain the main aspects of actual fluctuations. In particular, it is showed that demand shocks are able to explain fairly well the main aspects of actual fluctuations for the US economy into a two-sector general equilibrium model aggregate. This model, moreover, is not subject to crowding out effect, which is a problem peculiar of a one-sector general equilibrium model with where fluctuations are demand driven. This analysis, thus, brings together real business cycle theory into closer conformity not only with the prediction of Keynesian theory, but also with actual data.

Demand-Driven Business Cycles, Demand Uncertainty, External and Internal Finance, Keynesian Model

Abstract:
This paper implements a methodology that exploits firms and households' optimality conditions to measure money laundering for the Italian economy. This approach, first implemented by Ingram, Kocherlakota, and Savin (1997) to the household production sector, and by Busato, Chiarini and Di Maro (2006) for measuring the underground economy, allows to generate high frequency series for the money laundering using a theoretical two-sector dynamic general equilibrium model calibrated over the sample 1981:01-2001:04. The analysis of the generated series suggests two main results. First, money laundering accounts for approximately 12 percent of aggregate GDP; second, money laundering is more volatile than aggregate GDP, and it is negatively correlated with it.

Money Laundering; Two-sector Dynamic General Equilibrium Model; Illegal Economy

Abstract:
This paper introduces underground activities and tax evasion into a one sector dynamic general equilibrium model with external effects. The model presents a novel mechanism driving the self-fulfilling prophecies, which is triggered by the reallocation of resources to the underground sector to avoid the excess tax burden. This mechanism differs from the customary one, and it is complementary to it. In addition, the explicit introduction of an (even tiny) underground sector allows to reduce the aggregate degree of increasing returns required for indeterminacy, and for having well behaved input demand schedules (in the sense they slope down).

Dynamic General Equilibrium Models, Fiscal Policy, Tax Evasion and Underground Activities, Sunspots

Abstract:
This paper shows that underground activities and tax evasion may be another possible source of local indeterminacy of the equilibrium path. We derive necessary and sufficient conditions for equilibrium path to be locally indeterminate under tax evasion and underground activities. Moreover, the explicit introduction of an (even small) underground sector into a one-sector general equilibrium model allow to reduce aggregate degree of increasing returns required for indeterminacy, and for having well behaved input demand schedules (in the sense that slope down). Finally, we show that under indeterminacy, an increase in corporate, labor or income tax rates has a non-Keynesian effect, i.e. the economy enters into an expansionary pattern. These effects are reversed when the steady state is saddle-path stable.

Dynamic General Equilibrium Models, Fiscal Policy, Tax Evasion and underground Activities, Indeterminacy and Sunspots

Abstract:
The paper investigates the nexus between labor and financial markets, focusing on the interaction between labor union behavior in setting wages, firms' investment strategy and asset prices. The way unions set wage claims after observing firm's financial performance increases the volatility of firms' returns and the riskiness of corporate ownership. To remunerate this higher volatility and stronger risk, firms' equities have to grant high return. This mechanism is able to offer an explanation of for the "equity puzzle", that is it can explain the difference between equity returns and the risk free rate. It is a welcome result that the simulated excess return is about the empirical estimate and this result is obtained with a logarithmic specification of the shareholders preferences.

Equity Premium, General Equilibrium, Union Models

Abstract:
In this paper we show that in a two sector dynamic general equilibrium (DGE)model where part of produced capital is used as a production input in the originating sector, while remaining part is costly transferred to the other sector the optimal policies for consumption and investment are constant functions equal to zero.

Multisector Accumulation Models, Value Function

Abstract:
This paper introduces the concept of relative demand shocks into a multi-sector dynamic general equilibrium model. Relative demand shocks change the instantaneous structure of preferences. Under relative demand shocks consumer tastes randomly shift across different commodities, as manifested by unexpected relative increases or decreases in the marginal utility of the various consumption goods. There are no exogenous technology (productivity) shocks in the model. There are three main results. First, the model proposes an original heoretical mechanism for generating aggregate fluctuations and sectoral comovement by using inter-sectoral and idiosyncratic shocks. This mechanism is complementary to the standard Real Business Cycle theory. Second, the model is effectively able to reproduce the main stylized facts of the U.S. economy, also those that the standard Real Business Cycle model fails to explain. Third, the model generates a false Solow Residual, even though there is no technological progress in the model. Its size and time series properties are analogous to the actual Solow Residual.

Demand Shocks, Two-sector Dynamic General Equilibrium Models

Abstract:
This paper introduces the concept of relative demand shocks into a multi-sector dynamic general equilibrium model. Relative demand shocks change the instantaneous structure of preferences. Under relative demand shocks consumer tastes randomly shift across different commodities, as manifested by unexpected relative increases or decreases in the marginal utility of the various consumption goods. There are no exogenous technology (productivity) shocks in the model. There are three main results. First, the model proposes an original theoretical mechanism for generating aggregate fluctuations and sectoral comovement by using inter-sectoral and idiosyncratic shocks. This mechanism is complementary to the standard Real Business Cycle theory. Second, the model is effectively able to reproduce the main stylized facts of the U.S. economy, also those that the standard Real Business Cycle model fails to explain. Third, the model generates a false Solow Residual, even though there is no technological progress in the model. Its size and time series properties are analogous to the actual Solow Residual.

Demand Shocks, Two-sector Dynamic General Equilibrium Models

Abstract:
The main goal of this paper is to examine the implications of firm-oriented fiscal policies, such as capital subsidies and tax allowances, in an economy with an underground sector. In addition, we investigate whether the technology structure of "hidden" production may facilitate or counteract the effects of fiscal policies on firm behavior. Among our results we stress the following: first, capital subsidies promote tax evasion; these subsidies induce firms to increase actual capital accumulation (a level effect), but also produce a reduction in the regular share of aggregate capital stock (a composition effect).

Second, tax relief reduces underground activities and fosters capital accumulation, as well as aggregate production. Third, the technology structure matters for determining how to allocate resources between formal and informal production, hence the amount of reported revenues.

State aid, capital subsidies, tax evasion, underground production, physical capital accumulation

Abstract:
This paper generates high frequency data for the underground labor and the underground production using a theoretical general equilibrium model, over the sample 1970:01-1992:04 (32 years; 128 observations). We compare selected time series properties of the generated series with those of the corresponding series estimated with classical methodologies. The generated series for underground labor and underground production present a wider range and are more volatile than all other series estimated with classical methodologies. The analysis, next, suggests that the underground labor is pro-cyclical with respect to the GDP, that is lagging it by approximately one quarter, and that underground labor series generated from the theoretical model are highly persistent. Finally, the estimated correlation between the cyclical component of our generated-from-theory underground labor productivity and the actual series of aggregate GDP is negative (-0.34), while official yearly estimates present a positive (but very low) correlation with the cyclical component of GDP (0.12). This suggests that the underground sector has a positive impact over the productivity at the business cycle frequency, while it dampens productivity fluctuations at a lower frequency.

Real Business Cycle Models, Underground Economy

Abstract:
In this paper we investigate the effects of different fiscal policies on the firm choice to produce underground. We consider a tax evading firm operating simultaneously both in the regular and in the underground economy. We suggest that such a kind of firm, referred to as moonlighting firm, is able to offset the specific costs usually stressed by literature on underground production, such as those suggested by Loayza (1994) and Anderberg et al. (2003). Investigating the effects of different fiscal policy interventions, we find that taxation is a critical parameter to define the size of capital allocation in the underground production. In fact, a strong and inverse relationship is found, and tax reduction is the best policy to reduce the convenience to produce underground. We also confirm the depressing effect on investment of taxation (see, for instance, Summers, 1981), so that tax reduction has no cost in terms of investment. By contrast, the model states that while enforcement is an effective tool to reduce capital allocation in the underground production, it also reduce the total capital stock. Moreover, we also suggest that the allowance of incentives to capital accumulation may generate, in this specific typology of firm, some unexpected effects, causing, together with a positive investment process, also an increase in the share of irregularity. This finding could explain, in a microeconomic framework, the evidence of Italian southern regions, where high incentives are combined with high irregularity ratios.

evasion, moonlighting, capital subsidies, underground production

Abstract:
This paper shows under indeterminacy and tax evasion, an increase in corporate, labor or income tax rates pushes the economy into an expansionary pattern. These effects are reversed when the steady state is saddle-path stable.

Dynamic General Equilibrium Models, Fiscal Policy, Tax Evasion and Underground Activities, Indeterminacy and Sunspots

Abstract:
This paper presents an empirically testable two-sector dynamic general equilibrium model for the United States economy that admits technology and non-technology shocks. Long-run identification restrictions further distinguish the impact of each shocks over the originating sector (i.e. as a sector-specific), and over other sectors different from the originating one (i.e. as a cross-sector shock), also exploring the shocks transmission mechanism across sectors. There are three main results. First, business cycle are mainly generated, in each sector, by technology shocks (mainly described by sector-specific shocks), but they are transmitted across sectors along the sectors' demand side, i.e. passing through non-technology shocks. Second, technology and non-technology shocks almost equally share the responsibility of fluctuations in the aggregate manufacturing sector. Third, the dynamic behavior of the durable good sector may be well represented by a standard Real Business Model; the non-durable good sector, on the other hand, would not be consistent with that predictions. Overall, due to a size effect, the aggregate dynamics is driven by the relatively larger sector, which is the non-durable good one.

Long-run restrictions, sector-specific shocks, cross sector shocks, real business cycle, United States economy

Abstract:
This paper explores the ability of a class of one-sector, multi-input models to generate indeterminate equilibrium paths, and endogenous cycles, without relying on factors' hoarding. The model presents a novel theoretical economic mechanism that supports sunspot-driven expansions without requiring upward sloping labor demand schedules. Its distinctive characteristic is that the skill composition of aggregate labor demand drives expansionary i.i.d. demand shocks. Next, the model explains the labor market dynamics from the supply side, while endogenizing the capital productivity response to changes in the aggregate labor demand composition. Last but not least, it is worth to mention that the model presents an effective shock propagation mechanism that operates into the labor market and across labor market segments through the cross elasticities of equilibrium labor demand and supplies. In this respect the model can be seen as quite general formulation (with or without aggregate increasing returns to scale) for analyzing labor market dynamics within a general equilibrium model with labor market segmentation.

Indeterminacy and Sunspots, Skills

Abstract:
This paper studies equilibrium effects of fiscal policy within a dynamic general equilibrium model where tax evasion and underground activities are explicitly incorporated. In particular, we show that a dynamic general equilibrium with tax evasion may give a rational justification for a variant of the Laffer curve for a plausible parameterization. In this respect, the paper also identifies the different parameterization of the model formulation with tax evasion under which a Laffer curve exist. From a revenue maximizing perspective, the key policy messages are that bringing tax payers to compliance would be better than announcing to punish them if convicted, and that an economy without problems of compliance is much more sensitive to myopic behavior.

two-sector DGEM models, fiscal policy, tax evasion, underground activities

Abstract:
This paper studies equilibrium effects of fiscal policy disturbances within a dynamic general equilibrium model where tax evasion and underground activities are explicitly incorporated. There are three main results. (i) The underground sector mitigates the distortionary impact of fiscal policies, while lessening the drop (and the rise) of aggregate production after restrictive (expansionary) tax shocks. (ii) Tax evasion and underground economy can rationalize expansionary response to contractionary fiscal policies; (iii) A dynamic general equilibrium with tax evasion gives a rational justification for a variant of the Laffer curve.

Two-sector Dynamic General Equilibrium Models, Fiscal Policy, Tax Evasion and Underground Activities

Abstract:
This paper develops a two-sector dynamic general equilibrium model in which intermporal fluctuations (and sectoral comovement) are driven by idiosyncratic shocks to relative preferences between consumption goods. This class of shocks may be interpreted as shifts in consumer tastes. When shifts in preferences occur, consumers associate a new and different level of satisfaction to the same basket of consumption goods according to the modified preferences. The paper shows that, if the initial composition of the consumption basket is sufficiently asymmetric, a shift in relative preferences produces a so strong "perception effect" capable of inducing inter and intra sectoral positive comovement of the main macroeconomic variables (i.e., output, consumption, investment, and employment). It is a welcome result that these findings are reached without introducing either aggregate technology shocks, or input-output linkages or shocks perturbing the relative preference between aggregate consumption and leisure.

Demand Shocks, Two-sector Dynamic General Equilibrium Models