This article estimates the size of the Romanian shadow economy (SE) using the currency demand approach, in order to evaluate if there is any relationship between the SE and unemployment rate (UR). Using Granger causality tests and error correction models, we examine the impact of both registered and International Labour Office unemployment rates (ILO_UR) on the Romanian SE covering the period between 2000Q1 and 2010Q2. We find that the Romanian SE as a percentage of official gross domestic product (GDP) is decreasing over the analyzed period, from 36.5 percent at the end of 2000 to 31.5 of real GDP at the middle of 2010. Our empirical results also support a unidirectional Granger causality that runs from the URs to the SE. The generalized impulse response functions indicate the existence of a short-run negative relationship between URs and the Romanian SE. The empirical results also indicate that there is a positive long-run relationship between both URs and SE, with a 1 percent increase in URs leading to an increase in the SE of 0.36 percent due to the registered unemployment rate and an increase of 2.27 percent due to the ILO_UR.
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