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The Economic Growth–Inflation–Shadow Economy Trilogy: Developed Versus Developing Countries

This study investigates the nexus among the economic growth–inflation–shadow economy trilogy by including the role of political stability for a sample of 33 developed and 14 developing countries over the 2005–2016 period. For the OECD countries, our results showed a bidirectional nexus among economic growth and the size of the shadow economy while the causality running from economic growth to inflation, on the one hand, and from inflation to the informal economy, on the other hand, is unidirectional. As for the MENA panel, the relationship between inflation and the underground economy remains bidirectional, while the relationship running from inflation to economic growth, on the one hand, and from the informal economy to economic growth, on the other hand, is unidirectional. With the introduction of political stability, the nexus among the informal economy and the inflation in the OECD countries becomes unidirectional running from inflation to the shadow economy. However, in the case of MENA countries, controlling for political stability reduces the magnitude of the coefficient of the shadow economy on inflation. We note that with a low level of political stability, countries facing the large size of the informal sector will shift their financing from taxes to seigniorage.