Dynamic Interactions Between the Shadow Economy and Economic Policy Uncertainty: A Panel Var Approach

The literature on economic uncertainty has focused on the effects of uncertainty on the formal economy. Still, it has not addressed a relationship between uncertainty and shadow economy until now, to our knowledge. Therefore, this paper analyses the dynamic relationship between economic policy uncertainty and the shadow economy using panel vector autoregression estimates exploiting a dataset for 21 countries from 1997-2018. The impulse response analyses in this context reveal a mutual interaction of policy uncertainty and the shadow economy. In this respect, not only is the shadow economy found to respond to shocks in economic policy uncertainty, but also the uncertainty in economic policy appears to increase by a response to shocks in the shadow economy, implying a feedback effect from informal economic activities towards uncertainty. This effect is also thought to be responsible for aggravating negative influences of uncertainty on formal economic activities.