Abstract:

The paper aims at empirical evaluation of the relationship between the amount of cash in circulation and the size of the shadow economy. Using correlation and fixed effect panel regression analysis we examine a sample of 25 European OECD countries over the period 1991-2015. We run the panel regressions for the pooled sample as well as for several subsamples designed to control for the potential impact of geographical location, income disparities, and the overall surge in the money supply in the aftermath of the global financial crisis. Contrary to the basic intuition, we demonstrate that the long-run association between currency in circulation to GDP and the size of the shadow economy, measured as a percentage of GDP was generally negative (which in fact makes any causal relationship highly unlikely), or statistically insignificant. The evidence of a significant positive relationship was largely limited, both at the country and the cross-country level, and most pronounced in the pre-crisis period. Our findings suggest, therefore, that the long-run changes in the size of the shadow economy are driven primarily by non-cash factors. The results of the study might prove useful for both the development of regulatory policies aimed at reducing the shadow economy, and the improvement of the methods of its estimation.