Some papers say that informality makes prices stickier. For example, firms in the informal sector can increase output without bidding up wages. But if this is true, then why is there more inflation in poor economies (with a large informal sector) than in developed economies? So it seems the large inflation in poor economies is coming from something else, according to this literature.
But I think informality actually makes prices less sticky. In my country (where about 90% of the economy is informal), for example, I estimate that prices change every quarter using an NK model. Other papers using microdata say that the frequency of price change is even shorter, about one month, which kinda makes sense to me because our inflation rate is over 30% now.
My argument is that firms in the informal economy are mostly self-employed people, at least where I live. From real-life experience, if there is a shock, they just change the price the next day when you go to the market :). Maybe if they were not self-employed, it would be hard for them to change the price like. But if you are self-employed, you can change your wage however you want when there is a shock. It makes sense, yeah? Maybe the argument that informality makes prices stickier applies to emerging economies like Brazil, Peru, and others, but it does not seem to apply generally. Any comments are welcomed to clear up my confusion…:).
This is absolutely not my literature. I will nevertheless add a few thoughts.
When we are talking about inflation, is it measured inflation for goods in the formal sector? Or actual inflation including goods in the informal one?
Wages for self-employed are often not well-defined. There is no contract that defines what you are getting. So you may be right that this input’s price is quite flexible.
But production networks and input-output structures matter. If the informal sector does not produce inputs for the formal sector, then what happens there might be hardly relevant for inflation in the formal sector.
You asked why inflation is more volatile in poor countries. Part of the story surely is bigger shocks and a worse institutional capacity. Central banks in advanced economies are large sophisticated and independent institutions. That’s often different in countries with a large informal sector. For the latter, the central bank is often missing data to build its policy around.
Hi Prof. Pfeifer, may I ask something about this statement? So from my reading of macro texts, general statements like this are often made, which I agree with. But also, not every country will fit such a broad characterization. So for example, in this statement above, you will find individual developing countries where inflation is less volatile than in some rich countries. However, my impression (based on my knowledge of the macro literature so far) is that countries that do not fit these broad characterizations are often neglected…:)…I mean not so many researchers I think bother about why some countries do not conform to general rules (my opinion though).
Like in my country (a poor country), our business cycle is less volatile than many major developed countries (US, UK, Japan, Euro area, etc) from 1985 to 2010 (until we found oil in 2011). It is an interesting puzzle to me…and maybe there are other poor countries like that. But I do not think there are many papers that try to explain why some individual countries do not conform to general stylized facts. Countries that do not conform seem an interesting case to me…but is it? I mean in general macro research. Not sure what macro researchers typically think of such cases (as a novice macro researcher ).