Are Fiscal Rules Efficient on Public Debt Restraint in the Presence of Shadow Economy?

This paper provides an analysis of the role played by fiscal rules and the shadow economy on the evolution of public debt. Thus, we investigate the effectiveness of fiscal rules in limiting the level of indebtedness considering the presence of a shadow economy for 194 advanced, emerging, and developing countries over the period 1995-2021. The shadow economy has a negative impact on public revenue collection and leads to an increase in the budget deficit. A better management of public finance is hard to be realized in the presence of a shadow economy. The governments should try to limit the spread of the shadow economy in order to achieve sustainable public finances and maintain public indebtedness within reasonable limits.The relationship between the public debt, SE, and fiscal rules is analyzed based on the Generalized Method of Moments (GMM) for investigating the dynamic relation existing between variables. In addition, using Ganger causality is verified a potential bidirectional causality between variables. The main empirical findings confirm the significant contribution of the shadow economy to the public debt increase and the ineffectiveness of fiscal rules applied