Inflation and Endogenous Growth in Underground Economies

Dario Cziraky and Max Gillman

No 50, wiiw Balkan Observatory Working Papers from The Vienna Institute for International Economic Studies, wiiw

Abstract: The paper examines the effect of inflation on the growth rate in economies with underground, or ”non-market”, sectors. The model incorporates a non-market good into an endogenous growth cash-inadvance economy with human capital. Taxes on labor and capital induce substitution into the non-market sector which avoids such taxes. However the non-market sector uses only cash for exchange and cannot avoid the inflation tax, while the market sector allows costly credit use. We estimate a MIMIC model for latent underground economy using monthly data for Bulgaria, Croatia and Romania. Furthermore, we estimate a dynamic structural equation model and investigate short-run effects of the underground economy on output growth and test for Granger causality and long-run cointegrating relationships using bivariate Granger-causality tests and Johansen’s maximum likelihood technique. The result indicate different shares of underground economies across the three countries and a positive long-run effect of underground economy on output growth.

Keywords: Shadow economy; endogenous growth; dynamic structural equation modelling; latent variables (search for similar items in EconPapers)
JEL-codes: C31 C51 C52 E13 E31 O42 (search for similar items in EconPapers)
Date: 2004-06
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Citations: View citations in EconPapers (3)

Published as wiiw Balkan Observatory Working Paper

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