Labor supply elasticities and borrowing constraints

The labor-supply elasticity used in typical macroeconomic models is higher than the elasticity that labor economists estimate from microdata. We argue that assumptions underlying previous econometric estimates of the intertemporal labor supply elasticity are not consistent with heterogeneous agents economies with incomplete markets. In particular, if the econometrician ignores borrowing constraints, the elasticity will be biased downwards. Our preliminary finding is that this bias may be up to 50 percent.