Abstract:
Using a standard overlapping generations monetary production economy, faced with endogenously
determined tax evasion by heterogeneous agents in the economy, we provide a theoretical model that
indicates that both a lower (higher) level of financial development and a higher (lower) level of inflation
leads to a bigger (smaller) shadow economy. These findings are empirically tested within a panel econometric
framework, using data collected for 150 countries over the period 1980–2009 to enable a broad
generalisation of the results. The results support the developed theoretical model, even after having
accounted for the differences in the levels of economic development, the level of institutional quality that
includes different tax regimes and regulatory frameworks, central bank participation in the economy as
well as different macroeconomic policies.
