The mutual effects of shadow economy and financial development in Asean countries

Abstract

This study focuses on examining the mutual relationship between financial development and shadow economy by applying the theoretical and empirical framework. Our research contributed to the way of calculating the size of shadow economy applied the currency demand approach with updated data from 1997 to 2015 for 8 ASIAN countries. In particular, to have a robust result, we used 4 estimation methods including POLS, FEM, REM and SGMM to calculate the value of the size of shadow economy of each country. Then, we took each received results to examine the mutual effect with the financial development using P – VAR approach. We found that when the positive shock caused by the financial sector affects the shadow economy, the shadow economy will immediately respond negatively to the shock. On the other hand, when a positive shock caused by credit for private sector will lead to the positive responses of the shadow economy. Interestingly, in this case, the response tends to last longer with the estimated results from static model of shadow economy in comparison with dynamic model of shadow economy.