On Intertemporal Substitution and Aggregate Labor Supply - CiteSeerX

On Intertemporal Substitution and Aggregate Labor Supply

George S. Alogoskoufis Btrkhr,ck

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In this paper I present a n econometric investigation of the implications of the irlterternporal substitution hypothesis fhr aggregate ernployrnent in the United States. T h e tests are based on a version of the hypothesis with tirne-separable preferences. O n the basis of the evidence produced, the hypothesis is quite successful in explaining fluctuations in aggregate employment, although almost totally unin accounting for fluctuations in employee hours. These successf~~l findings suggest that the hypothesis rnight have an important role to play in macroeconornic rnodeling, although they contradict attempts to account for aggregate fluctuations solely in terrns of continuous competitive equilibrium in labor markets.

I.

Introduction

The labor market intertemporal substitution hypothesis (ISH), which states that labor supply responds positively to transitory increases in real wages and increases in the real interest rate, is a central hypothesis of modern, competitive models of the business cycle.' I would like to acknowledge the comments of. tbvo anonymous relerees, Aris Spanos, (:ostaz Rleghir, and participants at seniinars at Birkbeck and the Centre for Labour Economics, London School ol Economics, especially Charlie Bean, David (;rubb, and (:hris Pissarides. T h e undertaking of the extensive revision of this paper Irom its first incarnation owes a lot to the encouragement of Jarnes Heckrnan. As with many other important concepts in economics, the concept of intertemporal substitution call he traced back at least to Hicks (1939). Its recent emergence owes a lot to the influential paper by Lucas and Rapping (1961)), bvho also provided the fir-st aggregate test of the hvpothesis. For macroeconomic models that irnplicitlv or explicitl\ rely on ISH, see Lucas (197'L),Barro (1976),Brunner, Cukierman, and Rfeltzer (1980), (;rossnian and rl'eiss (1982), Alogoskouhs (1983), and others.

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P o l ~ l r ~ Fionum,, nl 1'3Xi. \ In this paper I am not mainly concerned with retrieving the parameters of the utility function. This requires heroic extra assumptions anyway and is not attempted. hly main concern is to obtain consistent estimates of the intertemporal real wage and interest rate elasticities of aggregate labor supply. T h e usefulness of ISH in explaining aggregate fluctuations in employment ultimately rests on the magnitude of these elasticities. Nevertheless, the estimates allow some inferences about the relative magnitude of the consumptionlleisure and interternporal substitution elasticities. My estimates suggest that, for measures of the total number of employees, the real wage and interest rate elasticities are high and relatively well determined. T h e overidentifying restrictions implied by the structural model are not generally rejected at conventional significance levels. This is surprising given that the model is rather parsimoniously specified and there is no state dependence. It cannot be explained only by the low power of general single-equation tests for overidentifying restrictions, such as the Basmann (1960) test utilized. For some of the specifications I also experimented with tests of the exclusion restrictions implied for particular subsets of the instruments. It turns out that, in some of the specifications, one could reject the exclusion restriction on the lagged dependent variable. This could be sufficient evidence against time-separable preferences. However, further work would be needed to consistently derive and test a generalized model augmented to allow for state dependence. It has to be emphasized that the estimates for the two measures of the total number of employees are otherwise very favorable to ISH, and other overidentifying restrictions cannot be rejected. For one of the measures of aggregate employee hours, the one divided by the working population with fixed age and sex composition, the estimated parameters are correctly signed, but the intertemporal real wage elasticity is somewhat lower than the estimated elasticity with measures of the number of employees. Furthermore, none of the parameters of interest is statistically significant at conventional significance levels. T h e results, however, are nowhere as negative as ' In many respects, the theoretical framelvork in this paper is similar to that of Barro and King (1984) and Xlankiw et al. (1985). I t relies on time-separable preferences and in this sense is a special, albeit important, case of ISH.

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INTERTEMPORAL S U B S T I T U T I O N

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You have printed the following article: On Intertemporal Substitution and Aggregate Labor Supply George S. Alogoskoufis The Journal of Political Economy, Vol. 95, No. 5. (Oct., 1987), pp. 938-960. Stable URL: http://links.jstor.org/sici?sici=0022-3808%28198710%2995%3A5%3C938%3AOISAAL%3E2.0.CO%3B2-%23

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Wage Movements and the Labour Market Equilibrium Hypothesis Joseph Altonji; Orley Ashenfelter Economica, New Series, Vol. 47, No. 187, Special Issue on Unemployment. (Aug., 1980), pp. 217-245. Stable URL: http://links.jstor.org/sici?sici=0013-0427%28198008%292%3A47%3A187%3C217%3AWMATLM%3E2.0.CO%3B2-%23 6

Time Series Representations of Economic Variables and Alternative Models of the Labour Market Orley Ashenfelter; David Card The Review of Economic Studies, Vol. 49, No. 5, Special Issue on Unemployment. (1982), pp. 761-781. Stable URL: http://links.jstor.org/sici?sici=0034-6527%281982%2949%3A5%3C761%3ATSROEV%3E2.0.CO%3B2-9 8

The Duhem-Quine Thesis, Lakatos and the Appraisal of Theories in Macroeconomics Rod Cross The Economic Journal, Vol. 92, No. 366. (Jun., 1982), pp. 320-340. Stable URL: http://links.jstor.org/sici?sici=0013-0133%28198206%2992%3A366%3C320%3ATDTLAT%3E2.0.CO%3B2-V

References NOTE: The reference numbering from the original has been maintained in this citation list.

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The Intertemporal Substitution Model of Labour Market Fluctuations: An Empirical Analysis Joseph G. Altonji The Review of Economic Studies, Vol. 49, No. 5, Special Issue on Unemployment. (1982), pp. 783-824. Stable URL: http://links.jstor.org/sici?sici=0034-6527%281982%2949%3A5%3C783%3ATISMOL%3E2.0.CO%3B2-J

Wage Movements and the Labour Market Equilibrium Hypothesis Joseph Altonji; Orley Ashenfelter Economica, New Series, Vol. 47, No. 187, Special Issue on Unemployment. (Aug., 1980), pp. 217-245. Stable URL: http://links.jstor.org/sici?sici=0013-0427%28198008%292%3A47%3A187%3C217%3AWMATLM%3E2.0.CO%3B2-%23

Unemployment in the United Kingdom Since the War Martyn Andrews; Stephen Nickell The Review of Economic Studies, Vol. 49, No. 5, Special Issue on Unemployment. (1982), pp. 731-759. Stable URL: http://links.jstor.org/sici?sici=0034-6527%281982%2949%3A5%3C731%3AUITUKS%3E2.0.CO%3B2-U

Time Series Representations of Economic Variables and Alternative Models of the Labour Market Orley Ashenfelter; David Card The Review of Economic Studies, Vol. 49, No. 5, Special Issue on Unemployment. (1982), pp. 761-781. Stable URL: http://links.jstor.org/sici?sici=0034-6527%281982%2949%3A5%3C761%3ATSROEV%3E2.0.CO%3B2-9

A Profitable Approach to Labor Supply and Commodity Demands over the Life-Cycle Martin Browning; Angus Deaton; Margaret Irish Econometrica, Vol. 53, No. 3. (May, 1985), pp. 503-544. Stable URL: http://links.jstor.org/sici?sici=0012-9682%28198505%2953%3A3%3C503%3AAPATLS%3E2.0.CO%3B2-P

NOTE: The reference numbering from the original has been maintained in this citation list.

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LINKED CITATIONS - Page 3 of 3 -

The Duhem-Quine Thesis, Lakatos and the Appraisal of Theories in Macroeconomics Rod Cross The Economic Journal, Vol. 92, No. 366. (Jun., 1982), pp. 320-340. Stable URL: http://links.jstor.org/sici?sici=0013-0133%28198206%2992%3A366%3C320%3ATDTLAT%3E2.0.CO%3B2-V

A Life Cycle Model of Female Labour Supply James J. Heckman; Thomas E. Macurdy The Review of Economic Studies, Vol. 47, No. 1, Econometrics Issue. (Jan., 1980), pp. 47-74. Stable URL: http://links.jstor.org/sici?sici=0034-6527%28198001%2947%3A1%3C47%3AALCMOF%3E2.0.CO%3B2-%23

Econometric Implications of the Rational Expectations Hypothesis Kenneth F. Wallis Econometrica, Vol. 48, No. 1. (Jan., 1980), pp. 49-73. Stable URL: http://links.jstor.org/sici?sici=0012-9682%28198001%2948%3A1%3C49%3AEIOTRE%3E2.0.CO%3B2-E

The Efficient Estimation of Econometric Models with Rational Expectations M. R. Wickens The Review of Economic Studies, Vol. 49, No. 1. (Jan., 1982), pp. 55-67. Stable URL: http://links.jstor.org/sici?sici=0034-6527%28198201%2949%3A1%3C55%3ATEEOEM%3E2.0.CO%3B2-A

NOTE: The reference numbering from the original has been maintained in this citation list.