Public expenditure multipliers and informality

Emilio Colombo, Davide Furceri, Pietro Pizzuto and Patrizio Tirelli

European Economic Review, 2024, vol. 164, issue C

Abstract: This paper investigates the role of informality in affecting the magnitude of the public expenditure multiplier in a panel of 142 countries, using the local projections method. We find a strong negative relationship between the degree of informality and the size of the multiplier. This result holds irrespective of the level of economic development and institutional quality and is robust to additional country characteristics such as trade and financial openness and exchange rate regime. In a two-sector New-Keynesian model, we rationalize this result by showing that fiscal shocks raise the relative price of official goods, thereby shifting demand towards the informal sector. This reallocation effect increases with the level of informality, because a larger informal sector is associated with a stronger appreciation of relative prices in response to fiscal shocks, and thus reduces the multiplier.

Keywords: Public expenditure multiplier; Local projection methods; Informality; DSGE model; TANK model (search for similar items in EconPapers)
JEL-codes: C32 E26 H30 H50 (search for similar items in EconPapers)
Date: 2024
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Working Paper: Public Expenditure Multipliers and Informality (2024)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:eecrev:v:164:y:2024:i:c:s0014292124000321

DOI: 10.1016/j.euroecorev.2024.104703

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