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This paper develops a new approach to estimating the degree of informality in an economy. It combines direct yet infrequent measures of the informal economy in micro data with an augmented factor model that links macro indicators of the informal economy to its causes. We show that the prevailing model used in the literature, the multiple indicators multiple causes model, is a special case of the augmented factor model and depicts an incomplete picture of the informal economy. Using the augmented factor model approach, we show that the dynamics of the informal economy is shaped by the strength of overall economic activity as well as the interplay between the formal and informal economies. Contrary to previous work that typically finds declining informality for most countries, we find that the degree of informality has increased for low-income countries for the past two decades.

Classification Methods --- Cluster Analysis --- Commodities --- Consumption --- Currency crises --- Econometric analysis --- Econometric models --- Econometrics & economic statistics --- Econometrics --- Economic & financial crises & disasters --- Economic sectors --- Economics of specific sectors --- Economics --- Economics: General --- Electric Utilities --- Electric utilities --- Electricity --- Factor Models --- Factor models --- Informal Economy --- Informal economy --- Informal sector --- Investment & securities --- Investments: Energy --- Macroeconomic Analyses of Economic Development --- Macroeconomics --- Macroeconomics: Consumption --- Monetary base --- Monetary economics --- Monetary Policy, Central Banking, and the Supply of Money and Credit: General --- Money and Monetary Policy --- Money supply --- Money --- National accounts --- Principal Components --- Saving --- Underground Econom --- Wealth