E-Money, Underground Economy and Optimal Policy

This paper analyzes the relation among the existence of e-money, official economic policies, and underground economy. In this model, each buyer receives a location shock and further enters whether underground economy or formal sector with a given probability. In addition, there is an e-money issuer who possesses investment technology and repays those who hold e-money with the return on investment. Besides, the government can affect the economy via either money supply or tax levy. As a result, if inflation rate and tax rate are sufficiently low, both cash and e-money exist; on the other hand, if either of them is too high, only cash circulates. The increase of inflation rate or tax rate will raise the transaction quantity of the underground economy comparing to the one of the formal sector. In comparison with pure cash economy, if cash and e-money coexist, the total transaction quantity would be higher, and the government would receive more revenue.