The unemployment volatility puzzle: the role of the underground economy

By Gaetano Lisi

Relying on the non-negligible role played by the underground economy in the labour market fluctuations, this paper extends the standard matching model à la Mortensen-Pissarides by introducing an underground sector along with an endogenous sector choice for both entrepreneurs and workers. These modifications improve the quantitative properties of the standard matching model, thus providing a possible explanation for the unemployment volatility puzzle.

It is too often forgotten that a substantial part of economic activity is not recorded. While home production has been considered in business cycle models, the underground economy has not. This paper shows that it matters, even when you limit yourself to observing outcomes in the visible economy.

2 Responses to The unemployment volatility puzzle: the role of the underground economy

  1. Rolf Campos says:

    It’s a nice idea. A paper by Paulina Restrepo has the same flavor. Link:

  2. c2granda says:

    Both Lisi (2010) and Restrepo Echavarría (2008) address the effect of the unofficial economy on the cyclical fluctuations of official macro aggregates. However, they focus on different variables and explanations. While Restrepo argues that the higher consumption volatility in developing countries is a natural consequence of large and poorly measured informal economies, Lisi claims the existence of underground activities per se might explain the unemployment volatility puzzle. In addition, they use different types of models to build their arguments: a search framework in his (Lisi’s) case, and a RBC setting closely related to the household production literature in hers (Restrepo’s). Even with these differences, the two papers add to the scant but certainly growing literature on the business cycles implications of unofficial economic activities, a topic well worth looking at…

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