Asymmetric effects of exchange rate volatility on the shadow economy: new evidence from OECD countries

Abstract

ABSTRACT Assessing the shadow economy and its major determinants has been an important part of economic literature over the past few decades. In this article, we analyse the impact of exchange rate volatility on the presence of the shadow economy for the current 38 OECD countries over the period of 1991–2021 in both a linear and nonlinear manner. We provide the opportunity to test whether an exchange rate adjustment may follow a nonlinear path and analyse the asymmetric impact of exchange rate volatility on the shadow economy. We estimate a linear ARDL model for each country and find support that exchange rate variability significantly affects the shadow economy both in the short run and long run in most countries both in linear and nonlinear models. However, by estimating a nonlinear ARDL model, we find an asymmetric exchange rate volatility effect in all 38 countries concluding that exchange rate volatility and risks associated with it significantly affects the shadow economy. Thus, it is crucial that this group of nations adequately implement financial policies to minimize this risk.