Abstract
We examine the effects of fiscal consolidation policies using a New Keynesian model with an underground sector, calibrated for the Greek economy. We find that spending cuts induce a reallocation of production towards the formal sector, thus reducing tax evasion . On the other hand, tax hikes increase the incentives to produce in the less productive underground sector, implying higher output and unemployment costs. We use the model to assess the recent fiscal consolidation plans in Greece . Our results provide evidence of an increase in underground activity during these consolidations. They also reveal significant output and welfare costs, which are exacerbated by the presence of the underground economy .
Pappa and Vella would like to acknowledge research funding from the John S. Latsis Public Benefit Foundation through the Programme “Scientific Projects”. The views expressed here in no way reflect those of the Bank of England.
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Pappa, E., Sajedi, R., Vella, E. (2017). Fiscal Consolidation Policies and the Underground Economy: The Case of Greece. In: Bournakis, I., Tsoukis, C., Christopoulos, D., Palivos, T. (eds) Political Economy Perspectives on the Greek Crisis. Palgrave Macmillan, Cham. https://doi.org/10.1007/978-3-319-63706-8_11
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DOI: https://doi.org/10.1007/978-3-319-63706-8_11
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