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Keywords:

  • business cycles;
  • informal sector;
  • panel data;
  • cyclicality

This article investigates the behaviour of the size of the shadow economy over the business cycle. To this end, it uses a panel dataset of 152 countries and finds strong evidence towards the counter-cyclicality of the informal sector size, that is, the size of the shadow economy as a ratio of gross domestic product (GDP) is reduced in booms and becomes bigger in busts. Empirical results are robust to different econometric specifications. This has serious consequences over the business cycle as it implies that the presence of the shadow economy increases the amplitude of the business cycles.