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

Author

Listed:
  • Sugata Marjit
  • Ranajoy Bhattacharyya
  • Lei Yang

Abstract

This paper provides a simple demonstration of an empirical observation pointed out by the existing literature that the presence of informality in the production sector of an economy moderates the impact of economic shocks affecting it. We show that 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 having substantial informal sector, largely more affluent nations, would be exposed more 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.

Suggested Citation

  • Sugata Marjit & Ranajoy Bhattacharyya & Lei Yang, 2023. "The Role of Informality in Moderating the Impact of Adverse Macroeconomic Shocks," CESifo Working Paper Series 10586, CESifo.
    • Handle: RePEc:ces:ceswps:_10586
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    File URL: https://www.cesifo.org/DocDL/cesifo1_wp10586.pdf
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    References listed on IDEAS

    as
    1. Marjit, Sugata & Kar, Saibal, 2011. "The Outsiders: Economic Reform and Informal Labour in a Developing Economy," OUP Catalogue, Oxford University Press, number 9780198071495.
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    More about this item

    Keywords

    informal sector; macroeconomic shocks; stagflation;
    All these keywords.

    JEL classification:

    • E23 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Production
    • E26 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Informal Economy; Underground Economy
    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy

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