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Does informality facilitate inflation stability?

Author

Listed:
  • Enrique Alberola-Ila
  • Carlos Urrutia
Abstract
Informality is an entrenched structural trait in emerging market economies, despite of the progress achieved in macroeconomic management. Informality determines the behavior of labour markets, financial access and the productivity of the overall economy. Therefore it influences the transmission of shocks and also of monetary policy. This paper develops a simple general equilibrium closed economy model with nominal rigidities, labor and financial frictions. Informality is captured by a dual labour market where the share of informal workers is endogenous. Only formal sector firms have access to financing, which is instrumental in their production process. Informality has a buffering effect on the propagation of demand and supply shocks to prices; the financial feature of the model exacerbates the impact of financial shocks in the formal sector while the informal sector is in principle unaffected. As a result informality dampens the impact of demand and financial shocks on wages and inflation but heighten the impact of technology shocks. Informality also increases the sacrifice ratio of monetary policy actions. From a Central Bank perspective, the results imply that the presence of an informal sector mitigates inflation volatility for some type of shocks but makes monetary policy less effective.

Suggested Citation

  • Enrique Alberola-Ila & Carlos Urrutia, 2019. "Does informality facilitate inflation stability?," BIS Working Papers 778, Bank for International Settlements.
    • Handle: RePEc:bis:biswps:778
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    Cited by:

    1. Bank for International Settlements, 2023. "Inflation and labour markets," BIS Papers, Bank for International Settlements, number 142.
    2. KOUAKOU, Dorgyles C.M. & YEO, Kolotioloma I.H., 2023. "Can innovation reduce the size of the informal economy? Econometric evidence from 138 countries," MPRA Paper 119264, University Library of Munich, Germany.
    3. Langot, François & Merola, Rossana & Oh, Samil, 2022. "Can taxes help ensure a fair globalization?," International Economics, Elsevier, vol. 171(C), pages 191-213.
    4. Thibault Lemaire, 2020. "Fiscal Consolidations and Informality in Latin America and the Caribbean," Documents de travail du Centre d'Economie de la Sorbonne 20004, Université Panthéon-Sorbonne (Paris 1), Centre d'Economie de la Sorbonne.
    5. Rojas Cama, Freddy & Emara, Noha & Trabelsi, Mohamed, 2024. "Financial inclusion and the informal sector," Research in International Business and Finance, Elsevier, vol. 70(PB).
    6. Shi, Tao & Li, Chongyang & Wanyan, Hong & Xu, Ying & Zhang, Wei, 2022. "The lending risk predicting of the folk informal financial organization from big data using the deep learning hybrid model," Finance Research Letters, Elsevier, vol. 50(C).
    7. Owolabi, Adegboyega O. & Berdiev, Aziz N. & Saunoris, James W., 2022. "Is the shadow economy procyclical or countercyclical over the business cycle? International evidence," The Quarterly Review of Economics and Finance, Elsevier, vol. 84(C), pages 257-270.
    8. Nahid Sultana & Mohammad Mafizur Rahman & Rasheda Khanam, 2022. "Informal Sector Employment and Economic Growth: Evidence from Developing Countries in SDG Perspective," Sustainability, MDPI, vol. 14(19), pages 1-19, September.
    9. André Marine Charlotte & Medina Espidio Sebastián, 2022. "Optimal Robust Monetary Policy in a Small Open Economy," Working Papers 2022-17, Banco de México.
    10. Gomez Ospina, Monica A., 2023. "Optimal monetary policy in developing countries: The role of informality," Journal of Economic Dynamics and Control, Elsevier, vol. 155(C).
    11. Eun Young Oh & Shuonan Zhang, 2022. "Informal economy and central bank digital currency," Economic Inquiry, Western Economic Association International, vol. 60(4), pages 1520-1539, October.
    12. Ghosh, Saurabh & Mazumder, Debojyoti, 2023. "Do NBFCs propagate real shocks?," Journal of Asian Economics, Elsevier, vol. 85(C).
    13. Central Reserve Bank of Peru, 2023. "eru: labour market, wages and monetary policy in the aftermath of Covid-19," BIS Papers chapters, in: Bank for International Settlements (ed.), Inflation and labour markets, volume 127, pages 221-236, Bank for International Settlements.
    14. De La Peña, Rogelio & García, Ignacio, 2023. "Untangling crises: GFC and COVID-19 through the lens of a DSGE model," Latin American Journal of Central Banking (previously Monetaria), Elsevier, vol. 4(2).
    15. Ruy Lama & Gustavo Leyva & Carlos Urrutia, 2022. "Labor Market Policies and Business Cycles in Emerging Economies," IMF Economic Review, Palgrave Macmillan;International Monetary Fund, vol. 70(2), pages 300-337, June.
    16. Oleg Lepekhin, 2024. "Convergence of Regional Food Inflation in Russia," Russian Journal of Money and Finance, Bank of Russia, vol. 83(3), pages 3-22, September.
    17. Daniel Guzmán, 2024. "Cyclical wage premia in the informal labour market: Persistent and downwardly rigid," Working Papers Central Bank of Chile 1012, Central Bank of Chile.
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    More about this item

    Keywords

    informality; inflation; monetary policy;
    All these keywords.

    JEL classification:

    • E26 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Informal Economy; Underground Economy
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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