Frisch Elasticity Research Articles

Living arrangements and labor market volatility of young workers

Household size is countercyclical, mainly because of young people moving into or delaying departure from the parental home. Those living in older households earn less and have more volatile hours than their peers living alone. We pose a theory of household formation and labor choice over the business cycle. Young people decide where to live depending on their wage, taste for living within the old household, and implicit transfers received. Our theory accounts for the bulk of the contribution of the household's size volatility to the volatility of the aggregate hours. Including people with varying living arrangements yields an implied aggregate, or macro, Frisch elasticity around 70 percent larger than the assumed micro elasticity.

The Norwegian tax holiday: Salience, labor supply responses, and frictions

AbstractAn emerging consensus is that the Frisch elasticity of labor supply is small. This may reflect a lack of salience, inelastic preferences, or prevalence of frictions. Studying survey data collected during a tax holiday in Norway, when earnings were untaxed during a transition between tax systems, I report three findings. First, 80 per cent of adults were aware of the tax holiday. Second, one fifth of adults responded by working more. Third, frictions in adjusting working hours or nonworking time appear to be the reason for a majority of nonresponses. The findings support the long‐held notion that labor supply choices are constrained.

Frisch elasticities in a model of indivisible labor supply with endogenous workweek length

AbstractIn this paper, I provide an extension of the classical indivisible labor supply model where a large macro Frisch elasticity is reconciled with a small micro counterpart. Households take as given state‐dependent hours per worker – shaped by a nonlinear mapping from hours worked to labor services and employment frictions – and make intertemporal labor supply decisions. In the standard indivisible labor supply model, aggregate fluctuations are independent of the individual preference parameter that governs the intensive‐margin elasticity. In my model, however, they are connected through the extensive margin whose elasticity is empirically reasonable and is shaped by the individual preference parameter.

Should Italy switch to a flat tax? An assessment based on a heterogeneous agents OLG model

We use a heterogeneous agents overlapping generations (OLG) model to quantitatively assess the impact of a reform in which a personal income tax with increasing marginal tax rates is replaced by a flat tax possibly complemented with a deduction. The value of the flat tax rate is set in order to balance the government budget and accordingly it increases with the value of the deduction. The model is calibrated and simulated for Italy. For low values of the deduction, aggregate labor supply increases, though this aggregate effect masks a completely different impact on the intensive and the extensive margin of labor supply: in particular, the activity rate is reduced by the introduction of a flat tax. As to inequality, it rises and this increase can be mitigated by using an higher value of the tax deduction, which however dampens down the positive effect of a flat tax on economic performance. Finally, the effect of a flat tax on social welfare crucially depends on the degree of inequality aversion embedded in the social welfare function and on the Frisch elasticity of labor supply.

Accounting for limited commitment between spouses when estimating labor-supply elasticities

The Frisch elasticity of labor supply can be estimated by regressing hours worked on the hourly wage rate, controlling for consumption of the individual worker. However, most household panel surveys contain consumption information only at the household level. We show that proxying individual consumption by household consumption biases estimated Frisch elasticities downward as limited commitment in the household induces individual consumption to behave differently from household consumption. We develop an improved estimation approach that eliminates this bias by exploiting information on the composition of household consumption to infer its distribution. Using PSID data, we estimate Frisch elasticities of about 0.65 for men and 0.8 for women.

Progressive consumption taxes

Whether consumption or labor income is progressively taxed is irrelevant to household choices and welfare in a static setting. Add dynamics to the problem and these two forms of progressivity have markedly different implications for how earnings vary along the life cycle: in a stylized life-cycle model, the progressive income tax reduces Frisch elasticities of labor supply whereas the progressive consumption tax reduces the elasticity of inter-temporal substitution. We explore the consequences of replacing the current U.S. tax system with one in which labor income taxes are linear and consumption taxes are progressive. We find welfare gains that exceed 10% in consumption equivalent variation terms in steady-state comparisons. An indirect consequence of the more variable earnings profile, greater asset accumulation, is found to be a very if not the most important quantitative aspect of progressive consumption taxes. Also important, when compared to labor income taxes, progressive consumption taxes are more positively correlated with inherited wealth. We take this aspect into account by considering a non–homothetic warm-glow motive that approximates the empirical distribution of wealth. We discuss several issues related to implementation and find that approximately half of the welfare gains are attained by using the information gathered by social security to implement income averaging in the sense of Vickrey (1947).

THE ROLE OF THE FRISCH ELASTICITY ON HOUSEHOLDS' BEHAVIOR USING THE ENDOGENOUS DISCOUNT FACTOR MODEL

Decisions made by households and society with regard to the economy are heavily influenced by the role and significance of the variables of discount factor and Frisch elasticity of labor supply, on capital formation and consumption, which are among the most significant sources of interest rate, consumption basket, and household leisure. The existence of the endogenous discount factor and the Frisch elasticity of labor supply, which demonstrate the patience of society with regard to consumption and the choice of the household's work-and-leisure mix, respectively, point to significant changes in the household's decisions that may influence the portfolio of consumption and leisure. In order to develop a DSGE model utilizing data from the Iranian economy for the years 1998 to 2020, this article explores the effects of two variables, the endogenous discount factor and Frisch's elasticity, on macroeconomic variables and household performance. The findings show that in a model with an endogenous discount component and a lower value of Frisch's elasticity, the effect of the technological shock on consumption, output, and household income variables is positive and more significant, but it is negative on the debt variable. Thus, it can be said that in general, given that the household is sensitive to the type of discount factor and the extent of the labor supply's Frisch elasticity and that these two factors are crucial in helping the household decide which purchases and activities to include in its basket of leisure activities in order to change its expected utility, an increase in Frisch's elasticity coefficient along with the endogenous discount factor in the household will change its expected utility. Additionally, this road has evolved into the best one for household decisions, and in the best distribution of resources, households place a higher value on leisure and self-importance.

Impact of oil price uncertainty shocks on China’s macro-economy

This study investigates the impacts of crude oil price uncertainty shocks on China’s macro-economy using empirical and theoretical approaches. The vector auto-regression with stochastic volatility in mean (VAR-SVM) model reveals that increasing oil price uncertainty significantly depresses output and raises inflation. To fully understand the transmission channels of oil price uncertainty shocks, we develop a new Keynesian dynamic stochastic general equilibrium (DSGE) model that incorporates oil demand of household, intermediate sector, and transportation sector. Increasing income uncertainty induced by high oil price volatility leads to enhanced precautionary saving and thus a decrease in consumption, particularly durable consumption, of individual households. The precautionary working mechanism is plausible in the changes of households’ labor supply and firms’ production behaviors when oil price uncertainty increases. Furthermore, with decreasing forward-looking market demand, intermediate firms choose higher prices to avert risk, which results in higher inflation in China. To explore how to mitigate the negative effects of oil price uncertainty, we consider a number of possible factors. The results illustrate that increasing competitiveness among transportation firms, reducing oil intensity of intermediate sector, targeting headline inflation by the central bank, and decreasing the Frisch elasticity of labor supply are effective measures. Our findings also suggest that deregulation of refined oil price in China would not amplify negative effects of oil price uncertainty.

On the measurement of the elasticity of labour

We use a simple theoretical framework, a building block of many macroeconomic models, to study the prominently debated relationship between the model parametrisation of the Frisch elasticity and the reduced-form evidence on the elasticity of labour. Focusing on tax holidays, we show that the elasticity measured with a reduced-form approach is only equal to the Frisch-elasticity parameter if there are no income or general equilibrium effects. Furthermore, for a wide range of standard values of the Frisch-elasticity parameter, the response of labour generated by a tax holiday in the model is aligned with the reduced-form evidence.

Higher taxes at the top? The role of tax avoidance

How does the presence of endogenous tax compliance alter optimal taxation in the United States? Using a full-scale macroeconomic model augmented with endogenous tax avoidance, I show that extremely high marginal tax rates for top earners cannot be sustained in equilibrium. Revenue- and welfare-maximising tax rates range between 36.4% and 38.4% in the long run, which are very close to the status quo. These results are robust to the calibration of the labour supply’s Frisch elasticity, and the labour response explains, at most, 60% of the variation of taxable income in the short run. Moreover, tax hikes on top earners are not effective redistribution mechanisms in the presence of tax avoidance.

Identifying key aspects of household behavior in a representative agent framework

We study three key aspects of household behavior, i.e. the form of household preferences, the existence of interdependence between consumption and leisure choices, and the Frisch elasticity of labor supply. We find that an appropriate form of household preferences to use in non-recursive utility functions that incorporates the feature of interdependence is of the Cobb-Douglas type. By solving the household maximization problem, we derive a simultaneous system of two equations, a consumption equation and a labor supply equation, and estimate them with non-linear GMM. Regarding our estimates, the weight of consumption in the utility function, which is on the upper side of the relevant estimates in the literature, and the elasticity of intertemporal substitution seem to drive up the Frisch elasticity value. Our work highlights the importance of both the choice of the form of household preferences and the appropriate estimation procedure in the household maximization problem for obtaining reasonable values of the preference parameters, especially the Frisch elasticity. Our results may be useful for researchers working with the calibration of preference parameters in DSGE models.

2SLS Using Weak Instruments: Implications for Estimating the Frisch Labor Supply Elasticity

There is a long standing controversy over the magnitude of the Frisch labor supply elasticity. Macro economists using DSGE models often calibrate it to be large, while many micro data studies find it is small. Several papers attempt to reconcile the micro and macro results. We offer a new and simple explanation: Most micro studies estimate the Frisch using a 2SLS regression of hours changes on income changes. But available instruments are typically weak. In that case, we show it is an inherent property of 2SLS that estimates of the Frisch will (spuriously) appear more precise when they are more shifted in the direction of the OLS bias, which is negative. As a result, Frisch elasticities near zero will (spuriously) appear to be precisely estimated, while large estimates will appear to be imprecise. This pattern makes it difficult for a 2SLS t-test to detect a true positive Frisch elasticity. We show how the use of a weak instrument robust hypothesis test, the Anderson-Rubin (AR) test, leads us to conclude the Frisch elasticity is large and significant in the NLSY97 data. In contrast, a conventional 2SLS t-test would lead us to conclude it is not significantly different from zero. Our application illustrates a fundamental problem with 2SLS t-tests that arises quite generally, even with strong instruments. Thus, we argue the AR test should be widely adopted in lieu of the t-test.

Accounting for Limited Commitment between Spouses When Estimating Labor-Supply Elasticities

The Frisch elasticity of labor supply can be estimated by regressing hours worked on the hourly wage rate, controlling for consumption of the individual worker. However, most household panel surveys contain consumption information only at the household level. We show that proxying individual consumption by household consumption biases estimated Frisch elasticities downward as limited commitment in the household induces individual consumption to behave differently from household consumption. We develop an improved estimation approach that eliminates this bias by exploiting information on the composition of household consumption to infer its distribution. Using PSID data, we estimate Frisch elasticities of about 0.7.

Оценка межвременной эластичности замещения предложения труда для замужних женщин в России

This paper provides an econometric analysis of the labor supply function of married women in Russia based on data from RLMS HSE and methodology from the work (Heckman, MaCurdy, 1980), in which decisions about entering the labor market and the intensity of work are made within a dynamic optimization problem. It is shown that the husband’s leisure and the number of children living in the household have a negative effect on the woman’s hours worked. The estimate of the Frisch elasticity of labor supply with respect to wages lies near 0.16.

Gender differences in the volatility of work hours and labor demand

This paper examines the role of heterogeneity in a real business cycle model, which traditionally has not fully captured the relative volatility of hours to output. Men and women have different cyclical volatilities in hours worked, which is robust to different filtering methods. This empirical regularity is used to motivate a standard RBC model augmented to allow for two different agents following Jaimovich et al. (2013). These two agents have identical utility functions, but face different elasticities of labor demand due to their different complementarities with capital. These estimated elasticities find that women are more complementary to capital. The calibrated model generates the cyclical volatility of work hours by gender and for the total hours worked that matches the U.S. data better than the traditional representative agent model. I then explore other extensions to this model including investigating the stability of the estimated labor demand elasticities and allowing for various Frisch elasticities of labor supply. This paper demonstrates that allowing for even broad levels of heterogeneity in a simple framework can increase the model’s tractability with the data. Since gender is important to explain U.S. business cycle dynamics, we need to carefully consider heterogeneity when analyzing counter-cyclical economic policy, as it may not have symmetric effects across assorted groups.

Consumption, reservation wages, and aggregate labor supply

This paper exploits micro data on the joint distribution of consumption and wages to measure the Frisch labor supply elasticity at the extensive margin. The approach is based on a derived reservation property of the working decision that holds in a class of models where the labor choice is intratemporal: given consumption, there exists a unique wage level above which individuals work and below which they do not. It is shown that this property is robust to heterogeneity in borrowing constraints, discount factors, and wage processes within the class of models. Applying it directly to the observed joint distribution of consumption and wages, I find that the aggregate Frisch elasticity at the extensive margin is 0.4 and that across various demographic groups, the elasticity ranges from 0.2 to 0.6. However, the elasticity variation is more pronounced across consumption groups and the elasticity is decreasing in consumption within demographic groups. The latter findings imply that the measured elasticity critically depends on the composition of consumption groups in the sample.

Employment and hours over the business cycle in a model with search frictions

This paper studies a large-firm search-matching model with variable hours of work to investigate how firms utilize the intensive and extensive margins of labor adjustment over the business cycle. The model replicates the observed cyclical behavior of the Japanese labor market, in which fluctuations in hours of work account for 79 percent of the variations in total labor input, well. Introduction of variable hours of work introduces the Frisch elasticity parameter into the analysis, and this is a key determinant of the magnitude of fluctuations in hours of work.

Reconciling Jaimovich–Rebello preferences, habit in consumption and labor supply

This note studies a form of a utility function of consumption with habit and leisure that (a) is compatible with long-run balanced growth, (b) hits a steady state observed target for hours worked and (c) is consistent with micro-econometric evidence for the inter-temporal elasticity of substitution and the Frisch elasticity of labor supply. Employing Jaimovich–Rebello preferences our results highlight a constraint on the preference parameter needed to target the steady-state Frisch elasticity. This leads to a lower bound for the latter that cannot be reconciled empirically with external habit, but the introduction of a labor wedge solves the problem. We also propose a dynamic Frisch inverse elasticity measure and examine its business cycle properties.

Labor Supply Responses and Adjustment Frictions: A Tax-Free Year in Iceland

Labor income earned in Iceland in 1987 went untaxed. I use this episode to study labor supply responses to temporary wage changes. I construct a new population-wide dataset of earnings and working time from pay slips and use two identification strategies to estimate intensive and extensive margin Frisch elasticities of 0.37 and 0.10, respectively. Workers with the ability to adjust drive these average responses: extensive margin responses by young and close-to-retirement cohorts and intensive margin responses by workers in temporally flexible jobs. However, constrained workers take up secondary jobs, which contribute to one-tenth of the overall response. Importantly, married women with children and the wives of men in temporally inflexible jobs respond more strongly than other women do. Within families, wives respond more than do their husbands, who themselves respond negatively to their wives’ tax cuts. This is consistent with substitutability in nonmarket time. Overall, my results suggest that adjustment frictions reduce aggregate labor supply responses to tax cuts and can similarly explain differences in elasticities within and across countries.

Aggregating Elasticities: Intensive and Extensive Margins of Women's Labor Supply

We show that there is substantial heterogeneity in women's labor supply elasticities at the micro level and highlight the implications for aggregate behavior. We consider both intertemporal and intratemporal choices, and identify intensive and extensive responses in a consistent life‐cycle framework, using US CEX data. Heterogeneity is due to observables, such as age, wealth, hours worked, and the wage level, as well as to unobservable tastes for leisure: the median Marshallian elasticity for hours worked is 0.18, with corresponding Hicksian elasticity of 0.54 and Frisch elasticity of 0.87. At the 90th percentile, these values are 0.79, 1.16, and 1.92. Responses at the extensive margin explain about 54% of the total labor supply response for women under 30, although this declines with age. Aggregate elasticities are higher in recessions, and increase with the length of the recession. The heterogeneity at the micro level means that the aggregate labor supply elasticity is not a structural parameter: any aggregate elasticity will depend on the demographic structure of the economy as well as the distribution of wealth and the particular point in the business cycle.