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The Intertemporal Substitution Model of Labor Supply in an Open Economy


  • João Ricardo Faria
  • Miguel León-Ledesma



The intertemporal substitution model of labor supply has been based on closed economy models. This paper studies the intertemporal substitution hypothesis in an open economy. It derives the long run labor supply as a function of the real wage, real interest rate and real exchange rate from a standard open economy optimizing representative agent model. The paper tests the steady state solution of the model for the US and, in order to avoid the Lucas critique, it tests for the superexogeneity of the interest rate and exchange rate. In accordance with the theory, the empirical evidence is supportive of the intertemporal substitution hypothesis, the significant impact of the real exchange rate, and is robust to the Lucas critique.

Suggested Citation

  • João Ricardo Faria & Miguel León-Ledesma, 2000. "The Intertemporal Substitution Model of Labor Supply in an Open Economy," Studies in Economics 0009, School of Economics, University of Kent.
  • Handle: RePEc:ukc:ukcedp:0009

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    References listed on IDEAS

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    4. Johansen, Soren, 1992. "Determination of Cointegration Rank in the Presence of a Linear Trend," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 54(3), pages 383-397, August.
    5. Alogoskoufis, George S, 1987. "Aggregate Employment and Intertemporal Substitution in the UK," Economic Journal, Royal Economic Society, vol. 97(386), pages 403-415, June.
    6. David Card, 1990. "Intertemporal Labor Supply: An Assessment," Working Papers 649, Princeton University, Department of Economics, Industrial Relations Section..
    7. Joseph G. Altonji, 1982. "The Intertemporal Substitution Model of Labour Market Fluctuations: An Empirical Analysis," Review of Economic Studies, Oxford University Press, vol. 49(5), pages 783-824.
    8. Dutkowsky, Donald H & Dunsky, Robert M, 1996. "Intertemporal Substitution, Money, and Aggregate Labor Supply," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 28(2), pages 216-232, May.
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    10. N. Gregory Mankiw & Julio J. Rotemberg & Lawrence H. Summers, 1985. "Intertemporal Substitution in Macroeconomics," The Quarterly Journal of Economics, Oxford University Press, vol. 100(1), pages 225-251.
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    12. David F. Hendry & Neil R. Ericsson, 1989. "An econometric analysis of UK money demand in MONETARY TRENDS IN THE UNITED STATES AND THE UNITED KINGDOM by Milton Friedman and Anna J. Schwartz," International Finance Discussion Papers 355, Board of Governors of the Federal Reserve System (U.S.).
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    14. Amartya Lahiri, 1996. "Macroeconomic Effects of Devaluation Rate Changes: Dynamic implications under alternative regimes of capital mobility," UCLA Economics Working Papers 760, UCLA Department of Economics.
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    Cited by:

    1. Hoon, Hian Teck & Phelps, Edmund S., 2007. "A structuralist model of the small open economy in the short, medium and long run," Journal of Macroeconomics, Elsevier, vol. 29(2), pages 227-254, June.

    More about this item


    Intertemporal substitution; Labor supply; Interest rate; Exchange rate;

    JEL classification:

    • D90 - Microeconomics - - Micro-Based Behavioral Economics - - - General
    • J22 - Labor and Demographic Economics - - Demand and Supply of Labor - - - Time Allocation and Labor Supply
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles

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