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The Informal Sector and the Welfare Effects of Inflation Targeting

Author

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  • Ahmed Kamara

    (Texas A &M University-Corpus Christi)

Abstract

In a quantitative framework featuring the informal sector, I show that, first, following a demand shock, inflation and the output gap are significantly more volatile in the presence of this sector than without it. For a supply shock however, I find that, while the informal sector amplifies volatility in the output gap, it has the opposite effect on inflation. Secondly, the presence of this sector increases the sacrifice ratio of monetary policy, thereby raising the output cost of stabilizing inflation. In this environment, targeting domestic inflation is the most effective policy in lowering the welfare cost of demand and supply shocks.

Suggested Citation

  • Ahmed Kamara, 2023. "The Informal Sector and the Welfare Effects of Inflation Targeting," Eastern Economic Journal, Palgrave Macmillan;Eastern Economic Association, vol. 49(4), pages 549-584, October.
    • Handle: RePEc:pal:easeco:v:49:y:2023:i:4:d:10.1057_s41302-023-00255-0
    DOI: 10.1057/s41302-023-00255-0
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    References listed on IDEAS

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    More about this item

    Keywords

    Informal sector; Fiscal policy; Inflation targeting; Welfare analysis;
    All these keywords.

    JEL classification:

    • E26 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Informal Economy; Underground Economy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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