Financial stress and shadow economy: A global study from a new worldwide database

Abstract

This paper is likely the first attempt to examine the dynamic behavior of the shadow economy following a financial stress shock in a global setting. We employ a novel Financial Stress Index that reflects not only the occurrence but also the intensity of financial stress. By using the local projection method on a global sample of 106 countries during the 1990–2018 period, we find that the shadow economy expands significantly following financial stress and this effect is persistent. However, this pattern is only present in advanced economies. The increase in the shadow economy in emerging and developing countries is transitory, and the magnitude of impact is much lower. We also document the non-linear relationship between the shadow economy and financial stress.