Adding an informal sector to the IS-LM framework: A graphical exposition of the IS-LM-PC-SE model for the classroom and policymaker

Celso J. Costa Junior and Alejandro C. Garcia-Cintado

Economic Systems, 2024, vol. 48, issue 2

Abstract: Economic policies have been shown to affect the macroeconomy in a different fashion when a sizeable shadow economy is explicitly taken into account. But, in spite of its seemingly high relevance, no intermediate-Macroeconomics textbook posits a discussion on this topic. In this paper, we seek to make a contribution by extending an otherwise conventional IS-MR-PC model along the same lines of the approach used in Blanchard’s highly acclaimed textbook (Blanchard, 2016a) to include an informal sector. We find that this two-sector model is capable of qualitatively reproducing the main basic results obtained in this literature. Therefore, importantly, this work provides a toolkit intended for undergraduate students, practitioners, policymakers, and, in general, nonspecialists on the cost-benefit analysis of economic policies in the presence of a significant underground economy.

Keywords: Undergraduate macroeconomics; Nonspecialists; Fiscal policy; Fiscal adjustments; Shadow economy; Tax evasion (search for similar items in EconPapers)
JEL-codes: A22 E00 E60 E62 H26 H30 (search for similar items in EconPapers)
Date: 2024
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Persistent link: https://EconPapers.repec.org/RePEc:eee:ecosys:v:48:y:2024:i:2:s0939362524000475

DOI: 10.1016/j.ecosys.2024.101225

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