The major macro-economic problems of the 1970s and the 1980s were integrally linked to the growing phenomenon of black income generation. The black economy should, therefore, have been a significant factor in analyses of the economy. Its non-inclusion in analyses resulted in a partial understanding of the Indian economy and often incorrect policy pronouncements. This paper describes the institutional practices of the black economy and incorporates it into the short run macro analysis of the Indian economy. The need to incorporate the black economy is not simply an empirical matter, but a theoretical necessity. The circular flow of incomes changes with the black economy. Black incomes are first defined. Transfers are not included, but their implications for national incomes, savings and velocity of circulation are presented. The theoretical analysis yields counter intuitive results with regard to tax evasion, investment and savings, subsidies, balance of payments, etc. The empirical trends since the 1970s, say, with regard to unemployment, inflation, the fiscal gap, current account deficit or investments and savings can be better explained using this framework.
