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The Effect of Liquidity Constraints on Labor Supply: Evidence from Interest Rate Ceilings

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Abstract

We exploit the spatiotemporal variation in US states’ interest rate ceilings on small-dollar loans to identify the effect of liquidity constraints on labor supply. Exogenously-capped interest rates lead to consumers being shut out of the market for cash loans. In response, labor supply increases by approximately 0.4 hours per week. We also find that the propensity to take personal leaves decreases. Labor supply, therefore, is used to overcome financial constraints, but is not the only method: the effect on earnings is less than many small-dollar loans, suggesting that borrowers employ multiple mechanisms to cope with tightened credit conditions.

Suggested Citation

  • Kabir Dasgupta & Brenden J. Mason, 2025. "The Effect of Liquidity Constraints on Labor Supply: Evidence from Interest Rate Ceilings," Finance and Economics Discussion Series 2025-110, Board of Governors of the Federal Reserve System (U.S.).
    • Handle: RePEc:fip:fedgfe:102370
    DOI: 10.17016/FEDS.2025.110
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    JEL classification:

    • D15 - Microeconomics - - Household Behavior - - - Intertemporal Household Choice; Life Cycle Models and Saving
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
    • G50 - Financial Economics - - Household Finance - - - General
    • J22 - Labor and Demographic Economics - - Demand and Supply of Labor - - - Time Allocation and Labor Supply

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