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

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  • Junior, Celso J. Costa
  • Garcia-Cintado, Alejandro C.

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.

Suggested Citation

  • Junior, Celso J. Costa & Garcia-Cintado, Alejandro C., 2024. "Adding an informal sector to the IS-LM framework: A graphical exposition of the IS-LM-PC-SE model for the classroom and policymaker," Economic Systems, Elsevier, vol. 48(2).
    • Handle: RePEc:eee:ecosys:v:48:y:2024:i:2:s0939362524000475
    DOI: 10.1016/j.ecosys.2024.101225
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    Keywords

    Undergraduate macroeconomics; Nonspecialists; Fiscal policy; Fiscal adjustments; Shadow economy; Tax evasion;
    All these keywords.

    JEL classification:

    • A22 - General Economics and Teaching - - Economic Education and Teaching of Economics - - - Undergraduate
    • E00 - Macroeconomics and Monetary Economics - - General - - - General
    • E60 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - General
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • H26 - Public Economics - - Taxation, Subsidies, and Revenue - - - Tax Evasion and Avoidance
    • H30 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - General

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