The relationship between interest rate volatility and the shadow economy in OECD countries: An asymmetric analysis

Abstract

Interest rate changes by central banks are a strong monetary policy tool that has a significant impact on the performance of the real economy via various channels. Despite extensive theoretical and empirical studies in this area, the current literature lacks a comprehensive assessment of the relationship between interest rate volatility and the shadow economy. This study explores the link between interest rate volatility and the shadow economy for 38 Organisation for Economic Co‐operation and Development (OECD) member countries over the period 1991–2021 using both linear and non‐linear ARDL models. The use of the non‐linear ARDL specification will allow for the possibility of an asymmetric effect of interest rate volatility on the shadow economy. In addition to the examination of the potential asymmetric effects, we also discuss the ramifications for policymakers with respect to monetary and financial policies while considering each country's specific economic structure.