Shadow Economies at Times of Banking Crises: Empirics and Theory
41 Pages Posted: 19 Jul 2013 Last revised: 21 Jul 2013
Date Written: February 1, 2013
This paper investigates the response of the shadow economy to banking crises. Our empirical analysis, based on a large sample of countries, suggests that the informal sector is a powerful buffer, which expands at times of banking crises and absorbs a large proportion of the fall in official output. To rationalise our evidence, we build a dynamic stochastic general equilibrium model which accounts for financial frictions and nominal rigidities. In line with the empirical literature on the shadow economy, we assume that in the informal sector access to external finance is limited, and the production tech- nology is relatively more labour intensive. Following a banking shock in the official sector, the model predicts a large negative transmission to the unofficial economy: about 60% of the official sector contraction is absorbed by the growth of the shadow economy.
Keywords: Financial crises, shadow economy, DSGE models
JEL Classification: E26, E32, E44
Suggested Citation: Suggested Citation