An ARDL model of unrecorded and recorded economies in Turkey

Purpose – The goal of this paper is twofold: to estimate the unrecorded economy (UE) of Turkey over the period 1987‐2007 using a revised version of the currency demand approach, and to analyze the relationship between the UE and recorded GDP. Design/methodology/approach – The paper proposes to measure the UE using the autoregressive distributed lag (ARDL) approach to cointegration analysis. Toda‐Yamamoto causality tests are also conducted to identify the relationship between unrecorded and recorded GDP. Findings – This research provides fresh evidence of the size of the UE relative to the recorded GDP in Turkey, which ranges from 10.7 percent to 18.9 percent over the estimation period. Moreover, empirical evidence concretely suggests that causality runs from the recorded GDP to the UE. However, there exists a mild reverse causality. Research limitations/implications – Measures of the UE, and particularly those based on monetary approaches, have been criticized on several counts, including their lack of robustness and weak theoretical foundations (e.g. the velocity of money in the recorded economy and in the UE is the same). Practical implications – This analysis suggests that the UE is pro‐cyclical with respect to the recorded GDP. It suggests that the phenomenon of the UE is more dangerous when the economy is in an expensive phase. Hence, during a positive business cycle, it is clearly desirable for the government that the anti‐UE controls should be more effective. Originality/value – The ARDL approach to estimating the size of the UE eliminates the criticism of the previous currency demand estimations, which were based on partial adjustment models. Therefore, the paper's econometric selected cointegration methodology and causality test is an improvement over the existing studies.