Informality and wealth distribution: A heterogeneous agent model

We postulate a continuous-time heterogeneous agent model that incorporates four key characteristics of informality: high informality size, interest rate premium, exemption from taxes, and greater risk aversion of informal agents. We use this framework to study the implications of informality for wealth and consumption distribution. Our results align with empirical research, showing that a substantial informal sector reduces overall median wealth and consumption levels while increasing their dispersion. We also identify differentiated contributions to this result from each of the four features of informality. Greater informality size and higher risk aversion among informal agents raise wealth dispersion, while a higher interest rate premium among informal agents lessens this statistic. Informal tax evasion, on the other hand, has only minor impacts on these results. This model can be extended to provide insights for designing economic policies in emerging and developing countries.