Money Multiplier Bias Due to Informal Sector: An Extension of the Existing Money Multiplier

To demonstrate the impact of informal economy on the official money multiplier in currency supply, we present an extension of the basic money multiplier model. The influence of economic policies may differ if they are based only on official statistics without considering the informal sector. Since m...

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Published inSouth Asian journal of macroeconomics and public finance Vol. 10; no. 2; pp. 139 - 157
Main Authors Mughal, Khurrum S., Schneider, Friedrich G., Aslam, Faheem, Tahir, Alishba
Format Journal Article
LanguageEnglish
Published New Delhi, India SAGE Publications 01.12.2021
Sage Publications, New Delhi India
Subjects
Economic policy
Informal economy
Money supply
Statistics
Taxation
money multiplier
Informal economy
shadow economy
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Summary:To demonstrate the impact of informal economy on the official money multiplier in currency supply, we present an extension of the basic money multiplier model. The influence of economic policies may differ if they are based only on official statistics without considering the informal sector. Since most of the activities in informal sector are hidden from authorities, it is widely assumed that these activities are based on cash transactions, a part of total currency that cannot be attracted towards deposits due to the holder’s fear of prosecution and taxation, etc. Therefore, it is expected that such currency holdings can give biased results by playing a role in the money multiplier, a phenomenon that is usually ignored while attempting to alter money supply. The article also indicates that because of informal sector, the currency deposit ratio in the money multiplier is smaller than expected (depending on size of the informal sector), leading to a larger multiplier effect. JEL Classifications: E26, E51, O17
ISSN:2277-9787
2321-0273
DOI:10.1177/2277978720979888