Estimating the size of the hidden economy in Peru: a currency demand approach

It is well established that informal activities are increasing around the world, particularly in developing countries. Quantifying these activities is difficult both from a conceptual and practical perspective. The method that has experienced greatest acceptance in the literature is the currency demand approach which supposes that the hidden economy is a response to changes in the tax burden or government regulation, and as a result there is an excessive use of cash in the economy. The present study follows this approach to estimate the size and evolution of the hidden economy in Peru for the period 1979-2005. Results under a conservative scenario indicate that the share of the hidden economy over total GDP in Peru has fluctuated between 44% and 50% in recent years. The results are robust to alternative econometric techniques and different model specifications. The standard assumption of unitary income-elasticity when imposing the same velocity of circulation in the formal and informal sector is also relaxed.