Two Cycle Stochastic Growth Model: Underground Economy, Investment Volatility and Taxation
38 Pages Posted: 17 Oct 2001
Date Written: April 2001
This paper develops a new theoretical framework, introducing into the traditional real business cycle model a second sector, which we interpret as representing the underground economy. We find that a model with an underground sector is quite successful in matching the stylized facts of the business cycle, improving some unsatisfactory results such as the employment volatility puzzle and productivity puzzle. Further, we show that it produces substantial internal propagation of temporary shocks. Then we explain how the underground activity helps to mitigate recessions and the cost of high tax burdens by allowing the household to smooth consumption through a proper labor allocation between the two sectors.
Keywords: Real business cycle, Underground Economy, Investment Volatility, Taxation
JEL Classification: E320, E260, E220, H200
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