Date Added: Mar 2010
In this paper the authors analyze the effects of informal labor markets on the dynamics of inflation and on the transmission of aggregate demand and supply shocks. In doing so, they incorporate the informal sector in a modified New Keynesian model with labor market frictions as in the Diamond-Mortensen-Passerines model. This main results show that the informal economy generates a "Buffer" effect that diminishes the pressure of demand shocks on aggregate wages and inflation. Finding that is consistent with the empirical literature on the effects of informal labor markets in business cycle fluctuations. This result implies that in economies with large informal labor markets the interest rate channel of monetary policy is relatively weaker.