The Political Stability - Inflation Nexus in South East Asia countries: Does Shadow Economy Moderate?

In recent years, the issues of the shadow economy and inflation, particularly in developing countries, have gained relevance and attracted huge attention in economic debates. This study investigates the relationship between political stability, shadow economy and inflation while explicitly accounting for the presence of the shadow economy in 8 ASEAN countries over the 2000 to 2017 period. The research analyzed data derived from the World Development Indicators of the World Bank and Medina & Schneider (2019). The study employs the dynamic ordinary least squares (DOLS) and fully modified ordinary least squares (FMOLS), which allow cross-sectional dependence and slope homogeneity in panel data analysis to investigate the relationship between shadow economy, political stability, and inflation. The results indicate that the higher level of the shadow economy contributes to the increasing inflation rate. However, the more political stability leads to the lower level of inflation. In addition, the impact of political stability on inflation rate really depends on the size of the shadow economy. The research could make substantial contributions to the ASEAN economies. The study provides empirical evidence for policymaker to consider when choosing optimal policies to manage inflation, political stability and policies related to limiting the size of shadow economy for sustainable development.