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The threshold relationship between financial development and shadow economy: Evidence from Taiwan
|Issue Date:||2021-07-01 20:30:05 (UTC+8)|
Most of pre-existing studies examine the relationship between financial development and the shadow economy by linear models, and financial development is usually proxied by banking development and stock market development. This paper adopts a non-linear threshold model to identify whether there is a non-linear relationship between financial development and the scale of shadow economy. The result shows that there is a non-linear relationship between banking development and the scale of shadow economy. At lower levels of banking development, that is, the ratio between bank credit to the private sector over GDP is less than 2.773, banking development has a significantly positive impact on the scale of the shadow economy. In contrast, the positive impact on the scale of the shadow economy decreases, and becomes insignificant at higher levels of banking development. On the other hand, the effect of stock market development on the scale of the shadow economy is linearly negative. As stated above, improving financial development in Taiwan does reduce the scale of shadow economy. In addition, the result of in-sample fits shows that the non-linear model outperforms the linear model, and the threshold relationship between banking development and the scale of the shadow economy is robust with respect to different estimation methods of the shadow economy.
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