Explaining cross-country differences in participation rates and aggregate fluctuations

The empirical evidence shows that there exists a negative relationship betw een the ratio of employment to population and the standard deviation of (lo g of) GDP. In this paper, we build a Real Business Cycle model with an unde rground economy sector in order to quantitatively address this issue. The e xistence of an alternative to registered market activities for providing tr adeable goods and services implies that population will be switching sector s in response to aggregate productivity shocks, amplifying the response of registered output. The level of participation in registered market activiti es will then be negatively related to fluctuations. This feature does not a rise in a standard one sector model. (C) 2002 Elsevier Science B.V. All rig hts reserved.