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Using Micro Data to Estimate the Intertemporal Substitution Elasticity for Labor Supply in an Implicit Contract Model

Author

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  • John C. Ham
  • Kevin T. Reilly
Abstract
Economists have devoted substantial resources to estimating the intertemporal substitution elasticity for labor supply because this elasticity plays a crucial role in the real business cycle literature. Generally, the estimates of the elasticity have been too low to explain business cycles. Economists have responded by trying to modify real business cycle models to allow for smaller elasticities, but they have experienced mixed success at best. However, the standard intertemporal substitution model has not done well when tested, and if this model is incorrect, so will be the estimated labor supply elasticities based upon it. An equilibrium alternative to the standard intertemporal labor supply model is the implicit contract model. In this latter model firms and workers bargain over state-contingent contracts denominated in terms of consumption and hours of work. Further, the price of leisure is the marginal product of labor or the shadow wage, which differs from the observed wage. A number of studies have found that the data are compatible with an implicit contract model; in particular in Ham and Reilly (2002) we found that we could reject a separable (within period) implicit contract model but not a non-separable one. If an implicit contract model is appropriate, this is the context in which we should try to estimate the intertemporal labor supply elasticity. However this estimation is potentially quite difficult with micro data since the shadow wage (marginal product of labor) is unobserved. In this paper we first develop a procedure that allows one to estimate the intertemporal substitution elasticity in an implicit contract model from micro data. We then implement this procedure using the Panel Study of Income Dynamics (PSID) and the Consumer Expenditure Survey (CES). We obtain statistically significant elasticities of 0.9 with the PSID and 1.0 with the CES. The consistency of the estimate across the data sets is impressive given that we use different estimation approaches (micro data versus synthetic cohorts) and different consumption measures (food consumption versus total nondurable consumption) in the two data sets. These results are three times larger than existing estimates based on the standard intertemporal supply elasticity from this data set and thus offer more hope that equilibrium perspectives on the labor market are capable of tracking the data. Given that the implicit contract model is less likely to be rejected than the standard model in our work and other research, we believe that our approach should prove to be quite useful.

Suggested Citation

  • John C. Ham & Kevin T. Reilly, 2006. "Using Micro Data to Estimate the Intertemporal Substitution Elasticity for Labor Supply in an Implicit Contract Model," IEPR Working Papers 06.54, Institute of Economic Policy Research (IEPR).
    • Handle: RePEc:scp:wpaper:06-54
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    Citations

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    Cited by:

    1. Richard Rogerson & Johanna Wallenius, 2018. "Household Time Use Among Older Couples: Evidence and Implications for Labor Supply," 2018 Meeting Papers 90, Society for Economic Dynamics.
    2. Daniel O. Beltran & David Draper, 2018. "Estimating dynamic macroeconomic models: how informative are the data?," Journal of the Royal Statistical Society Series C, Royal Statistical Society, vol. 67(2), pages 501-520, February.
    3. Gary D. Hansen, "undated". "Business Cycle Fluctuations and the Life Cycle: How Important is Learning by Doing? (with Selo Imrohoroglu)," UCLA Economics Online Papers 421, UCLA Department of Economics.
    4. Richard Rogerson & Johanna Wallenius, 2019. "Household Time Use among Older Couples: Evidence and Implications for Labor Supply Parameters," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 134(2), pages 1079-1120.
    5. Luisa Fuster & Ayşe İmrohoroğlu & Selahattin İmrohoroğlu, 2007. "Elimination of Social Security in a Dynastic Framework," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 74(1), pages 113-145.
    6. Daniel O. Beltran & David Draper, 2008. "Estimating the parameters of a small open economy DSGE model: identifiability and inferential validity," International Finance Discussion Papers 955, Board of Governors of the Federal Reserve System (U.S.).
    7. Vipul Bhatt & Masao Ogaki, 2012. "Tough Love And Intergenerational Altruism," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 53(3), pages 791-814, August.
    8. Hlavac, Marek, 2008. "Fundamental Tax Reform: The Growth and Utility Effects of a Revenue-Neutral Flat Tax," MPRA Paper 24241, University Library of Munich, Germany.

    More about this item

    JEL classification:

    • E30 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - General (includes Measurement and Data)
    • J22 - Labor and Demographic Economics - - Demand and Supply of Labor - - - Time Allocation and Labor Supply
    • J60 - Labor and Demographic Economics - - Mobility, Unemployment, Vacancies, and Immigrant Workers - - - General

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