Informality and macroeconomic volatility: do credit constraints matter?

Abstract

Purpose – The purpose of this paper is to study the implications of borrowing constraints characterizing the informal sector for macroeconomic volatility. Design/methodology/approach – To this end, the author develops a simple dynamic stochastic general equilibrium model wherein registered activity not only is the basis to determine tax liabilities, but also serves as collateral for securing debts. Such a framework allows for computational experiments to analyze the effect of informality on aggregate fluctuations. Findings – The experiments show that the credit-constrained informal sector does exert a significant influence on the cyclical volatility of consumption and investment. Originality/value – There are not many studies addressing the implications of informal economic activities for macroeconomic fluctuations. This paper contributes to the literature by developing a theoretical model showing that credit constraints characterizing these activities might play a non-negligible role in explaining the cyclical volatility of some important aggregates.

Noncompliant behaviors in general equilibrium: A survey

“…They also find that, beyond state capacity, the presence of this fundamental friction can yield a lower ratio of tax revenue to GDP in poor countries. 14 In fact, the resulting reduction in the internal sources of funding impinges on the financial accelerator and renders consumption less volatile, as in Granda-Carvajal (2015). 15 The same result appears in the empirical paper by Abdel-Latif et al (2017), who differs from Colombo et al (2016) for three reasons.…”

“…The effects of NCBs on financial frictions How do NCBs affect financial frictions? The literature provides a twofold answer (Granda-Carvajal, 2015). First, underreporting reduces the collateral that firms can show and therefore worsens their terms and conditions for potential formal debt contracts.…”

Tax Evasion, Investment Shocks, and the Consumption Puzzle: A DSGE Analysis with Financial Frictions

“…Furthermore, our results importantly emphasize the alternative between self‐financing originating from tax evasion and borrowing, thus highlighting the role of tax evasion for credit constrained agents. Most of the literature (Dabla‐Norris and Feltenstein , Blackburn, Bose, and Capasso ) has so far emphasized that tax evasion exacerbates credit constraints via a collateral mechanism, implicitly assuming “book‐tax‐conformity.” Within this line of research, Granda Carvajal () argues that tax evasion also plays an important role in providing additional financial means. In our framework, the Granda Carvajal () self‐financing effect is further reinforced, because we remove the assumption of “book‐tax‐conformity.” In fact, in our model the external finance premium is motivated by a “costly state verification.” There are no credit ceilings affected by the size of tax evasion.…”

“…Most of the literature (Dabla‐Norris and Feltenstein , Blackburn, Bose, and Capasso ) has so far emphasized that tax evasion exacerbates credit constraints via a collateral mechanism, implicitly assuming “book‐tax‐conformity.” Within this line of research, Granda Carvajal () argues that tax evasion also plays an important role in providing additional financial means. In our framework, the Granda Carvajal () self‐financing effect is further reinforced, because we remove the assumption of “book‐tax‐conformity.” In fact, in our model the external finance premium is motivated by a “costly state verification.” There are no credit ceilings affected by the size of tax evasion. Our interpretation finds support in Desai (), who suggests that the U.S. are characterized by significant disjunction between financial statements that report “book profits” to the capital markets and those reporting “tax profits” to the government.…”

“…First, as far as we know, no paper has investigated the tax evasion phenomenon in the financial accelerator framework. We think this is an interesting point to stress given that engaging in tax evasion practices can be an answer to financial frictions (Dabla‐Norris and Feltenstein , Straub , Gobbi and Zizza , Blackburn, Bose, and Capasso ), which have been identified as important determinants of business fluctuations as well (CMR , , , Granda Carvajal ) (see also Christiano, Trabandt, and Walentin ) . Second, in general equilibrium settings, standard shadow economy literature models tax evasion at the final firm level.…”