Scandinavian Working Papers in Economics

SSE/EFI Working Paper Series in Economics and Finance,
Stockholm School of Economics

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

David Domeij () and Martin Floden ()
Additional contact information
David Domeij: Dept. of Economics, Stockholm School of Economics, Postal: Stockholm School of Economics, P.O. Box 6501, S-113 83 Stockholm, Sweden
Martin Floden: Dept. of Economics, Stockholm School of Economics, Postal: Stockholm School of Economics, P.O. Box 6501, S-113 83 Stockholm, Sweden

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

JEL-codes: C20; C50; E20; J22

30 pages, November 29, 2001

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