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Is GDP more volatile in developing countries after taking the shadow economy into account? Evidence from Latin America

Mario Solis-Garcia and Yingtong Xie

MPRA Paper from University Library of Munich, Germany

Abstract: Why is GDP more volatile in developing countries? In this paper we propose an explanation that can account for the substantial differences in the volatility of measured real GDP per capita between developing and developed countries. Our explanation involves the often overlooked fact that developing economies have a sizable shadow economy. We build a two-sector model that distinguishes between measured (formal) and total (formal and shadow) outputs; using data from Latin America, our model results suggest that developing and developed economies are fairly similar in terms of the volatility of total real GDP. We also document an apparent puzzle, in that the model suggests that the volatility of the size of the shadow economy should be substantially larger than what is observed in the real world. We believe that this may be indicative of frictions that prevent agents from optimally moving between the formal and shadow economies.

Keywords: shadow economy; business cycles; DSGE models; Bayesian estimation (search for similar items in EconPapers)
JEL-codes: E26 E32 O17 (search for similar items in EconPapers)
Date: 2017-03-30
New Economics Papers: this item is included in nep-dge, nep-iue and nep-mac
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