Estimating Labor Supply Elasticities with Joint Borrowing Constraints of Couples

Conventional estimates of Frisch labor supply elasticities are biased in the presence of borrowing constraints. We develop an incomplete-markets model with two-earner households and derive a new estimation approach for the Frisch elasticity that yields unbiased estimates even in samples that include borrowing-constrained households. Our approach exploits that the strength of the estimation bias depends on individuals’ relative contribution to household earnings. It takes the form of a simple interaction term model with minimum data requirements. Using Panel Study of Income Dynamics data, we estimate Frisch elasticities of about 0.7 for men and rather homogeneous Frisch elasticities across the population.