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The Economic Research Institute, Stockholm School of Economics SSE/EFI Working Paper Series in Economics and Finance

No 480:
The labor-supply elasticity and borrowing constraints: Why estimates are biased

David Domeij () and Martin Floden ()

Abstract: The labor-supply elasticity is a central element in many macroeconomic models. We argue that assumptions underlying previous econometric estimates of the intertemporal labor supply elasticity are inconsistent with incomplete markets economies. In particular, if the econometrician ignores borrowing constraints, the elasticity will be biased downwards. Within our model, the bias may be up to 50 percent. We find a similar bias in PSID data.

Keywords: labor supply elasticity; intertemporal substitution; liquidity constraints; (follow links to similar papers)

JEL-Codes: C20; C50; E20; J22; (follow links to similar papers)

30 pages, November 29, 2001

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This paper is published as:
Domeij, David and Martin Floden, (2006), 'The labor-supply elasticity and borrowing constraints: Why estimates are biased', Review of Economic Dynamics, Vol. 9, No. 2, pages 242-262

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