Does Informality facilitate Inflation Stability?

Enrique Alberola and Carlos Urrutia ()

No 216, 2019 Meeting Papers from Society for Economic Dynamics

Abstract: Informality is an entrenched structural trait in emerging market economies, despite of the progresses achieved in macroeconomic management. Informality determines the behavior of labour markets, financial access and the productivity of the overall economy. Therefore it influences the transmission of shocks and also of monetary policy. This paper develops a simple general equilibrium closed economy model with nominal rigidities, labor and financial frictions. Informality is captured by a dual labour market where the share of informal workers is endogenous. Only formal sector firms have access to financing, which is instrumental in their production process. Informality has a bu↵ering e↵ect on the propagation of demand and supply shocks to prices; the financial feature of the model boosts the impact of financial shocks in the formal sector while the informal sector is in principle unaffected. As a result informality dampens the impact of demand and financial shocks on wages and inflation but heighten the impact of technology shocks. Informality also increases the sacrifice ratio of monetary policy actions. From a Central Bank perspective, the results imply that the presence of an informal sector mitigates inflation volatility for some type of shocks but makes monetary policy less effective.

Date: 2019
New Economics Papers: this item is included in nep-cba, nep-iue, nep-mac and nep-mon
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Citations: View citations in EconPapers (8)

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Related works:
Journal Article: Does informality facilitate inflation stability? (2020)
Working Paper: Does informality facilitate inflation stability? (2019)
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed019:216

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