Robust Inference for the Frisch Labor Supply Elasticity

Michael Keane () and Timothy Neal

No 2021-07d, Discussion Papers from School of Economics, The University of New South Wales

Abstract: The Frisch labor supply elasticity plays a key role in many policy debates, but its magnitude remains controversial. Many studies use 2SLS regressions of hours changes on wage changes to estimate the Frisch elasticity. But a little appreciated power asymmetry property of 2SLS causes estimates to appear (spuriously) imprecise when they are shifted away from the OLS bias. This makes it difficult for a 2SLS t-test to detect a true positive Frisch elasticity. We illustrate this problem in an application to NLSY97 data. We obtain a Frisch estimate of 0.60 for young men, but the t-test indicates it is insignificant. In contrast, the Anderson-Rubin (AR) test – which avoids the power asymmetry problem – implies the estimate is highly significant. The same power asymmetry issue that afflicts the t-test here will arise in many IV applications. Thus, we argue the AR test should be widely adopted in lieu of the t-test.

Keywords: Frisch elasticity; labor supply; weak instruments; 2SLS; Anderson-Rubin test; LIML; Continuously Updated GMM (search for similar items in EconPapers)
JEL-codes: C12 C26 D15 J22 (search for similar items in EconPapers)
Pages: 30 pages
Date: 2022-12
New Economics Papers: this item is included in nep-lma
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Related works:
Working Paper: Robust Inference for the Frisch Labor Supply Elasticity (2023)
Working Paper: Robust Inference for the Frisch Labor Supply Elasticity (2022)
Working Paper: Robust Inference for the Frisch Labor Supply Elasticity (2021)
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