Frisch Elasticity Of Labor Supply Research Articles

The anatomy of the aggregate labor supply elasticity

We show that the aggregate Frisch elasticity of labor supply can greatly exceed the corresponding individual-level parameter, and we illustrate the “anatomy” of the former in terms of intensive and extensive margins. The methodology consists of using micro data from the PSID to construct a panel of individuals and an aggregate time series obtained by aggregating these individuals each year. These two data sets represent exactly the same sample at different levels of aggregation, and we use them to identify the parameters of two distinct MaCurdy-type micro and macro equations. We find a micro elasticity of about 0.1 and a much larger macro elasticity that ranges from 1.1 to 1.7. There is no conflict between the two estimates: the micro one reflects only the intensive margin while the macro one reflects, in addition, the much more volatile extensive margin. Furthermore, aggregation of only continuously employed individuals allows us to provide a reliable estimate of the intensive margin elasticity in the range 0.3–0.4. This implies an extensive margin elasticity in the range 0.8–1.4. These findings suggest that micro evidence is not a benchmark for assessing how large the Frisch elasticity of labor supply should be in a model of the aggregate economy.

Reconciling Cyclical Movements in the Marginal Value of Time and the Marginal Product of Labor

Recessions appear to be times when the marginal rate of substitution between goods and workers’ time falls below the marginal product of labor. If so, the allocation of workers’ time is inefficient. I develop a model of households and production that reconciles cyclical movements in the marginal value of time and the marginal product. The model embodies the findings of research that the Frisch elasticity of labor supply is less than one. It treats unemployment in a search‐and‐matching setup. Recessions do not result in private inefficiency in the allocation of labor, but the unemployment rate may be socially inefficiently high.

The Transmission of Domestic Shocks in the Open Economy

This paper uses an open economy DSGE model to explore how trade openness affects the transmission of domestic shocks. For some calibrations, closed and open economies appear dramatically different, reminiscent of the implications of Mundell-Fleming style models. However, we argue such stark differences hinge on calibrations that impose an implausibly high trade price elasticity and Frisch elasticity of labor supply. Overall, our results suggest that the main effects of openness are on the composition of expenditure, and on the wedge between consumer and domestic prices, rather than on the response of aggregate output and domestic prices.

Fiscal Policy and Macroeconomic Stabilizations: What are the Gains from Cooperation?

In this paper we extend the open-economy stochastic framework of Obstfeld and Rogoff (Q J Econ. 117:503–36, 2002) to include distortionary taxation, when prices are flexible but wages are sticky. We use the model to analyze the optimal design of tax rules that respond to productivity shocks, under non-cooperation and cooperation between the fiscal authorities, and evaluate the gains from coordination. We show that, although monetary policy would be preferred to fiscal policy as a stabilization tool both under competition (Nash) and under cooperation, there is a role for procyclical fiscal stabilization in a monetary union where the monetary authority cannot respond to asymmetric shocks. Moreover, we show that in the Nash game there will be an incentive for the fiscal authorities to try to manipulate the terms-of-trade in their favor, and we estimate the potential gains from fiscal policy coordination. The size of the gains depends crucially on the value of the Frisch elasticity of labor supply. For lower values of the Frisch elasticity (more in line with microeconometric estimates) the gains are relatively small, but for more elastic labor supplies (more in agreement with the business cycle literature) the gains can be very large.

Explaining Asset Prices with External Habits and Wage Rigidities in a DSGE Model

In this paper, I investigate the scope of a model with exogenous habit formation - or `catching up with the Joneses`, see Abel (1990) - to generate the observed equity premium as well as other key macroeconomic facts. Along the way, I derive restrictions for four out of eight parameters for a rather general preference specification of habit formation by imposing consistency with long-run growth, the leisure share, the aggregate Frisch elasticity of labor supply, the observed risk-free rate, and the observed Sharpe ratio. I show that a DSGE model with (exogenous and lagged) habits in both leisure and consumption, but not necessarily with additional persistence, is well capable of matching the observed asset market facts as well as macro facts, provided one allows for moderate real wage stickiness and provided one allows for sufficient curvature on preferences, as dictated by the asset market observations. Without wage stickiness, delivery on both the asset pricing implications as well as the macroeconomic implications seems to be much harder.

Explaining Asset Prices with External Habits and Wage Rigidities in a DSGE Model

In this paper, I investigate the scope of a model with exogenous habit formation - or catching up with the Joneses, see Abel (1990) - to generate the observed equity premium as well as other key macroeconomic facts. Along the way, I derive restrictions for four out of eight parameters for a rather general preference specification of habit formation by imposing consistency with long-run growth, the leisure share, the aggregate Frisch elasticity of labor supply, the observed risk-free rate, and the observed Sharpe ratio. I show that a DSGE model with (exogenous and lagged) habits in both leisure and consumption, but not necessarily with additional persistence, is well capable of matching the observed asset market facts as well as macro facts, provided one allows for moderate real wage stickiness and provided one allows for sufficient curvature on preferences, as dictated by the asset market observations. Without wage stickiness, delivery on both the asset pricing implications as well as the macroeconomic implications seems to be much harder.

The Transmission of Domestic Shocks in the Open Economy

This paper uses an open economy DSGE model to explore how trade openness affects the transmission of domestic shocks. For some calibrations, closed and open economies appear dramatically different, reminiscent of the implications of Mundell-Fleming style models. However, we argue such stark differences hinge on calibrations that impose an implausibly high trade price elasticity and Frisch elasticity of labor supply. Overall, our results suggest that the main effects of openness are on the composition of expenditure, and on the wedge between consumer and domestic prices, rather than on the response of aggregate output and domestic prices.

Markups, Gaps, and the Welfare Costs of Business Fluctuations

In this paper we present a simple theory-based measure of the variations in aggregate economic efficiency: the gap between the marginal product of labor and the household's consumption/leisure tradeoff. We show that this indicator corresponds to the inverse of the markup of price over social marginal cost, and give some evidence in support of this interpretation. We then show, that, with some auxilliary assumptions our gap variable may be used to measure the efficiency costs of business fluctuations. We find that the latter costs are modest on average. However, to the extent the flexible price equilibrium is distorted, the gross efficiency losses from recessions and gains from booms may be large. Indeed, we find that the major recessions involved large efficiency losses. These results hold for reasonable parameterizations of the Frisch elasticity of labor supply, the coefficient of relative risk aversion, and steady state distortions.

Markups, Gaps, and the Welfare Costs of Business Fluctuations

We present a simple theory-based measure of the variations in aggregate economic efficiency: the gap between the marginal product of labor and the household's consumption leisure tradeoff. We show that this indicator corresponds to the reciprocal of the markup of price over social marginal cost, and give some evidence in support of this interpretation. We then show that, with some auxiliary assumptions, our gap variable may be used to measure the efficiency costs of business fluctuations. We find that the latter costs are modest on average. However, to the extent that the flexible price equilibrium is distorted, the gross efficiency losses from recessions and gains from booms may be large. Indeed, we find that the major recessions involved large efficiency losses. These results hold for reasonable parameterizations of the Frisch elasticity of labor supply, the relative risk aversion, and steady-state distortions.