ISSN (Print) - 0012-9976 | ISSN (Online) - 2349-8846

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The Role of Informality in Moderating the Impact of Adverse Macroeconomic Shocks

In the presence of informality, adverse demand shocks have a lower impact on aggregate output and adverse supply shocks have a lower impact on prices as well as output. Both would imply that countries without a substantial informal sector, largely more affluent nations, would be more exposed to higher prices following such shocks. This is consistent with contemporary evidence of stagflation in developed countries. Being the residual sector, the informal sector inevitably moves in the opposite direction to the formal sector during a bad shock episode, cushioning its aggregate effect. We then show that the argument goes through if the firms have to finance their working capital requirements by borrowing
from the market.

The authors are indebted to Pintu Parui for comments on an earlier version of the article.

Many theoretical studies have demonstrated that the presence of an informal economy generates a buffer effect or serves as a shock absorber that diminishes the pressure of a demand shock (Castillo and Montoro 2010; Alberola and Urrutia 2019; Lambert et al 2020). Empirical studies like, for instance,

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Published On : 20th Jan, 2024

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