Abstract
One of the most important policy considerations currently for all governments across the European Union (EU) concerns the need to increase tax revenue so as to reduce their unsustainable budget deficits. One key policy involves reducing the amount of revenue lost as a result of the ‘cash economy’, but before this is possible they first need to have some idea of its size. This study provides evidence of the importance of the cash economy across the EU and suggests that changes in house prices, when the Euro was formed in 1999 can be used as a basis to measure its magnitude. These results build on the theoretical model on how individuals who wished to hide their domestic cash from the authorities when the European single currency was formed in 1999, would have needed to acquire a physical asset, most likely property. This implies changes in property prices between the announcement of the Euro and its implementation reflect the level of wealth being hidden in this way and therefore the extent of the cash economy.
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Notes
Other related studies have analysed the economics of the related topic of money laundering, these include Masciandaro (1999).
What is illegal can vary substantially from economy to economy.
Other theoretical studies have approached modelling the black economy from other perspectives, for instance Huang and Wu (1994) model this phenomenon with respect to the ‘social norm’ approach.
For a detailed description of the formation and management of the Euro, De Grauwe (2000) has a comprehensive coverage.
Event studies are typically carried out using stock price data and involving either a market model or a form of the Capital Asset Pricing Model. A specific policy change is then used incorporating dummy variables to determine if it had a significant effect on the stock price. This approach has similarities in that instead of the return on stock prices, the return on house prices is used. However interpretation of the dummy variable is similar in this case.
However this event is likely to have been a leaky one, with some individuals anticipating that their countries would be allowed to join before May 1998. As a result other windows were included in the model, for instance with the ‘window’ of ones from 1991 (signing of Maastricht treaty) to 1999, however these tended not to work as well as the ‘window’ used. Finding the appropriate ‘window’ length is a common problem with event type studies, as there is no set way of determining it, the approach used here has been based on policy changes as well as the best empirical fit.
A potential alternative to the individual time series approach used here, would have been to construct a panel of these countries. This was used in Goodhart and Hofmann (2006) to determine causality between the housing market and other macroeconomic factors. However there is likely to be considerable heterogeneity across these EU housing markets as noted earlier, which would induce bias into our estimates. In addition we are not expecting this effect to be relevant in all the countries in this sample, so the time series is more suited to our overall aims. Another alternative would be to use microeconometric approaches, however again there was no suitable data on a micro level available.
An attempt to quantify the size of the cash economy can be based on these estimates. Taking the Netherlands as an example, our estimates indicate an excess return of 7,000 Euros over the two quarters. With approximately 100,000 homes sold over this time period and assuming that all the excess return was used as a medium of exchange, it implies about 14 million Euros were laundered. Assuming a M0 velocity of about 32, it suggests about 0.12 % of annual GDP being in the cash economy.
In this respect it is interesting to note that Professor Willem Buiter claims that the high denomination euro bank notes (200 and 500 bills) are “making the euro the currency of choice for underground and black economies…” and that Feige (2012) reports how the fraction of the US money stock made up of $100 bills grew from 20.9 % in 1963 to 73.3 % in 2008.
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Acknowledgments
An early version of this paper was presented at the conference ‘The Shadow Economy, Tax Evasion and Money Laundering’ at the Munster School of Business Administration and Economics, University of Munster, Germany in July 2011. The authors are very grateful for comments received then and those of two anonymous journal referees. The usual disclaimer applies.
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Cullis, J., Morley, B. A methodology for determining the ‘cash economy’ in the European Union via an announcement effect. Eur J Law Econ 44, 113–129 (2017). https://doi.org/10.1007/s10657-014-9451-2
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DOI: https://doi.org/10.1007/s10657-014-9451-2