9th INTERNATIONAL CONFERENCE ON KNOWLEDGE, ECONOMY & MANAGEMENT PROCEEDINGS ULUSLAR ARASI 9. BLG, EKONOM VE YÖNETM KONGRES BLDRLER Jun 23-25, 2011 Sarajevo-Bosnia & Herzegovina / 23-25 Haziran 2011, Saraybosna-Bosna Hersek 1017 INFORMATION BIAS IMPARTED BY THE HIDDEN ECONOMY AND ITS IMPLICATIONS ON DEMAND-MANAGEMENT POLICIES: THE TURKISH CASE Fatih Savasan * Temel Gürdal ** Abstract This paper reconsiders Blanchard and Quah decomposition of aggregate output. They decompose aggregate output using temporary and permanent shocks which are then interpreted demand and supply shocks, respectively. This paper applies the technique for total output, official output plus hidden output. We conclude that hidden output does not matter much for the case of Turkey. This implies that if government is to follow demand management policies the hidden output would not matter much. Key Words: vector autoregression, aggregate demand and supply, hidden output Özet Bu makale toplam üretimin Blanchard ve Quah (B&Q) ayrıımını yeniden ele almaktadır. Blanchard ve Quah geçici ve sürekli okları kullanarak üretimi ayrıtırıp, okları talep ve arz okları olarak yorumlamaktadır. Bu çalımada ise teknik kayıtdıı sektörü de dikkate alarak Türkiye örneine uyarlanmaktadır. Kayıtdıı üretimin bu ayrıımda önemli olmadıı sonucuna ulaılmaktadır. Bu sonuç, kayıtdıı sektörün devletin talep yönetimi politikalarını etkilemeyecei eklinde yorumlanabilir. 1. Introduction Some economic activities go unreported or unmeasured in our standard measures of economic performance (Feige, 1989). These activities are defined as the hidden economy. A fairly common conclusion from the empirical literature is that the hidden economy is large and its size varies over time in response to economic circumstances. Evidence of a significant hidden economy has been found for developing and developed countries alike. Existence of a hidden economy can have important policy implications. Tax evasion is a primary motivation for hidden activity, and the consequence of evasion is lost tax revenue. A hidden economy can also cause the income distribution that occurs following a change in taxes to differ from the distribution that policy was designed to achieve. An increase in taxes may divert economic activity underground because it drives a wedge between net returns in the official and the hidden sectors. The existence of an underground or hidden sector also creates an information bias in macroeconomic variables. Besides calculation and observational errors 1 , the GDP measurements fail to account for activities in the hidden sector of the economy. Various statistics from the national income accounts are derived from tax records. Any distortion in * Doç.Dr., Sakarya University, Faculty of Economics and Administrative Sciences Department of Public Finance, Sakarya, Turkey. e-mail: fsavasan@sakarya.edu.tr ** Doç.Dr., Sakarya University, Faculty of Economics and Administrative Sciences Department of Public Finance, Sakarya, Turkey, e-mail: tgurdal@sakarya.edu.tr 1 According to Feinstein (1972), errors in GNP can be as large as 5% of the recorded GNP.