Overseas Holdings of U.S. Currency and the Underground Economy

Many public policy decisions require analytical and empirical knowledge concerning the size, growth, causes and consequences of the ‘underground economy”. This paper seeks to clarify the meaning of underground activity, updates various discrepancy and fiscal estimates of its size and growth, and examines the empirical implications of new evidence concerning the growing use of US currency (dollarization) throughout the world for indirect estimates of the underground economy in the U.S. The paper examines all indirect and direct methods of estimating the amount of US currency held abroad and concludes that between 40% -45% of US currency is held abroad. This result stands in sharp contrast to the estimates presented by Porter and Judson (1996) who claim that as much as 55% -70% of US currency is held abroad. The new estimates of overseas currency are used to derive a domestic currency series which is the appropriate variable for use in currency demand models that purport to provide estimates of the size of the underground economy. This paper appears in Exploring the Underground Economy: Studies of Illegal and Unreported Activity. Susan Pozo (ed.) W.E Upjohn Institute for Employment Research, Kalamazoo, MI, 1996