{
  "title": "Informality and Shock Propagation in an Open Economy",
  "publication": "IMF Working Papers, September 26, 2025",
  "sourceUrl": "https://www.imf.org/en/publications/wp/issues/2025/09/26/informality-and-shock-propagation-in-an-open-economy-570599",
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  "summary": "The informal sector accounts for a large fraction of the economy and labor force in many emerging market and developing economies. This paper develops a dynamic stochastic general equilibrium model of a small open economy with an informal sector.",
  "sections": [
    {
      "heading": "Summary",
      "content": "- The informal sector accounts for a large fraction of the economy and labor force in many emerging market and developing economies.\n- The paper develops a dynamic stochastic general equilibrium model of a small open economy with an informal sector.\n- Nominal price and wage rigidities are present in the formal sector, while prices and wages are flexible in the informal sector.\n- Production of traded goods relies more on formal inputs (which can be produced at home or imported) while non-traded goods rely more on informal inputs.\n- The informal sector, despite its costs, can provide a flexible margin of adjustment in labor and product markets which helps buffer the impact of domestic and external shocks."
    },
    {
      "heading": "Model and Mechanisms",
      "content": "- Framework: dynamic stochastic general equilibrium model of a small open economy with an explicit informal sector.\n- Price and wage rigidities:\n  - Formal sector: nominal price and wage rigidities.\n  - Informal sector: prices and wages are flexible.\n- Input composition:\n  - Traded goods: rely more on formal inputs (domestic or imported).\n  - Non-traded goods: rely more on informal inputs.\n- Adjustment channel: the informal sector provides flexibility in labor and product markets, serving as a buffer against shocks."
    },
    {
      "heading": "Key Findings",
      "content": "- Informality functions as a shock absorber by permitting flexible adjustments in labor and product markets.\n- The presence of an informal sector mitigates the transmission of domestic and external shocks to the formal economy.\n- The trade-off: informality carries costs but delivers stabilization benefits through flexibility."
    },
    {
      "heading": "Policy Implications and Considerations",
      "content": "- Recognize the role of the informal sector as a flexible margin of adjustment in macroeconomic shock absorption.\n- Policies aimed at formalization should consider potential trade-offs between reducing costs of informality and losing a flexible buffer against shocks.\n- Design of stabilization and labor-market policies should account for differential nominal rigidities across formal and informal sectors."
    },
    {
      "heading": "Subject Areas and Keywords",
      "content": "- Subjects: Consumption, Inflation, Informal employment, Labor, Labor markets, National accounts, Prices\n- Keywords: Caribbean, Consumption, Europe, IMF working papers, Inflation, inflation rate, Informal employment, informal sector, Informality, investment goods, Labor markets, nominal price, Shock Propagation, South Asia, Sub-Saharan Africa\n\nSource: IMF Working Papers — \"Informality and Shock Propagation in an Open Economy\", Working Paper No. 2025/190, Sandra Valentina Lizarazo and Brandon Joel Tan, September 26, 2025.\n\n---\n\n Content in this bundle\n\n- Working Paper\n  - Working Paper (Markdown version){rel=\"alternate\" type=\"text/markdown\"}\n  - Working Paper (PDF){rel=\"external\" type=\"application/pdf\"}\n\n---\n\nSource: https://www.imf.org/en/publications/wp/issues/2025/09/26/informality-and-shock-propagation-in-an-open-economy-570599"
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    "Authors: Sandra Lizarazo, Brandon Joel Tan",
    "Published: September 26, 2025",
    "Series: IMF Working Papers",
    "DOI: https://doi.org/10.5089/9798229024280.001",
    "The informal sector accounts for a large fraction of the economy and labor force in many emerging market and developing economies.",
    "The paper develops a dynamic stochastic general equilibrium model of a small open economy with an informal sector.",
    "Nominal price and wage rigidities are present in the formal sector, while prices and wages are flexible in the informal sector.",
    "Production of traded goods relies more on formal inputs (which can be produced at home or imported) while non-traded goods rely more on informal inputs.",
    "The informal sector, despite its costs, can provide a flexible margin of adjustment in labor and product markets which helps buffer the impact of domestic and external shocks.",
    "Framework: dynamic stochastic general equilibrium model of a small open economy with an explicit informal sector.",
    "Price and wage rigidities:",
    "Input composition:",
    "Adjustment channel: the informal sector provides flexibility in labor and product markets, serving as a buffer against shocks.",
    "Informality functions as a shock absorber by permitting flexible adjustments in labor and product markets.",
    "The presence of an informal sector mitigates the transmission of domestic and external shocks to the formal economy.",
    "The trade-off: informality carries costs but delivers stabilization benefits through flexibility.",
    "Recognize the role of the informal sector as a flexible margin of adjustment in macroeconomic shock absorption.",
    "Policies aimed at formalization should consider potential trade-offs between reducing costs of informality and losing a flexible buffer against shocks.",
    "Design of stabilization and labor-market policies should account for differential nominal rigidities across formal and informal sectors.",
    "Subjects: Consumption, Inflation, Informal employment, Labor, Labor markets, National accounts, Prices",
    "Keywords: Caribbean, Consumption, Europe, IMF working papers, Inflation, inflation rate, Informal employment, informal sector, Informality, investment goods, Labor markets, nominal price, Shock Propagation, South Asia, Sub-Saharan Africa",
    "**Working Paper**"
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