Essays on the Informal Economy
Open Access DepositedThe informal or shadow economy can account for up to 70% of a developing country’s GDP, while in developed nations, it typically represents around 15%. This highlights the crucial role the informal sector plays in shaping economic outcomes. However, despite its significant impact, policymakers often overlook its presence and influence. This dissertation is structured into three chapters, each exploring the effects of the informal sector under various scenarios. Using DSGE models, exogenous shocks, and empirical data, the research aims to provide a deeper understanding of how the informal economy influences broader economic decision-making and responses.Chapter 1 explores the role of the informal sector in an economy affected by macroeconomic shocks and fluctuations, examining whether its presence amplifies or mitigates economic volatility. Given the informal sector’s size and distinct characteristics, understanding its influence on macroeconomic variables during the business cycle is essential. This chapter develops a closed-economy New Keynesian DSGE model that incorporates an informal sector and two macroeconomic shocks
a total factor productivity (TFP) shock and a government consumption shock. The informal sector is modeled as a labor-intensive segment where agents can evade taxes on informal income and consumption. The model is designed to reflect the dynamics of developed economies such as Greece, Italy, or Portugal, where the informal sector accounts for roughly 15 percent of GDP and capital is relatively limited. The results suggest that the informal sector increases macroeconomic volatility in response to a TFP shock but reduces it when facing a government consumption shock. Chapter 2 shifts focus to the impact of climate change on the informal sector, particularly in developing economies where the sector accounts for up to two-thirds of GDP and provides substantial employment. This chapter examines how the informal sector’s size is influenced by environmental factors, especially CO2 emissions. Pollution may expand the informal economy by shifting production from the formal sector (“scale effect”), but it can also reduce its size through stricter regulations (“substitution effect”) or environmental shocks that disrupt informal sector operations (“contraction effect”). To investigate this, the study first analyzes an annual dataset of 140 developed and developing economies spanning 1996 to 2021, assessing how the informal sector’s size correlates with climate variables such as CO2 emissions, while controlling for other factors. The second part of the chapter develops a DSGE model that includes both formal and informal sectors, environmental externalities, and financial frictions to further examine how the climate crisis affects the informal sector. The results support the “substitution” and “contraction” effects, suggesting that environmental degradation typically leads to a contraction in the informal economy. Chapter 3 examines the interaction between the informal sector and an optimized Taylor rule. Using a similar model framework as in Chapter 1, the chapter aims to maximize consumer utility by identifying the optimized Taylor rule coefficients. It then introduces a TFP shock as and compares the macroeconomic responses in an economy with and without an informal sector. The chapter also contrasts these results with those from Chapter 1, illustrating how the presence of the informal sector influences the respective weights that the central bank places on inflation and the output gap. The results suggest the optimized Taylor under the presence of an informal sector rule places less emphasis on inflation and more weight on stabilizing the output gap. This adjustment happens because output volatility becomes more costly, both due to the inherent volatility of the informal sector and because fluctuations in the formal sector can have a significant impact on the size and dynamics of the informal sector.
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Chondrogianni_gwu_0075A_17379.pdf | 2025-12-11 | Open Access |
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