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The Labor-Supply Elasticity and Borrowing Constraints: Why Estimates are Biased

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  • David Domeij

    (Stockholm School of Economics)

  • Martin Floden

    (Stockholm School of Economics)

Abstract

The intertemporal labor-supply elasticity is often a central element in macroeconomic analysis. We argue that assumptions underlying previous econometric estimates of the labor supply elasticity are inconsistent with incomplete-markets economies. In particular, if the econometrician ignores borrowing constraints, the elasticity will be biased downwards. We assess this bias using artificial data generated by a model in which we know the true elasticity and real-world data from the Panel Study of Income Dynamics. When applying standard econometric methods on the artificial data, we estimate an elasticity that is 50 percent lower than the true elasticity. We find evidence of a similar bias when using real-world data. (Copyright: Elsevier)

Suggested Citation

  • David Domeij & Martin Floden, 2006. "The Labor-Supply Elasticity and Borrowing Constraints: Why Estimates are Biased," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 9(2), pages 242-262, April.
    • Handle: RePEc:red:issued:v:9:y:2006:i:2:p:242-262
    DOI: 10.1016/j.red.2005.11.001
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    More about this item

    Keywords

    Keywords: Frisch labor-supply elasticity; Liquidity constraint; Panel Study of Income Dynamics; Monte Carlo experiment;
    All these keywords.

    JEL classification:

    • E24 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity
    • J22 - Labor and Demographic Economics - - Demand and Supply of Labor - - - Time Allocation and Labor Supply

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