The Labor Supply Response to (Mismeasured But) Predictable Wage Changes
Review of Economics and Statistics
37 Pages Posted: 28 Feb 2001 Last revised: 15 Jan 2011
Date Written: September 1, 2000
Problems with measurement error have led many researchers to criticize panel data studies of intertemporal labor supply. In this study I address the measurement error problems explicitly. I estimate the properties of measurement error in the Panel Study of Income Dynamics Validation Study. I then use this information about measurement error to purge measurement error from the Panel Study of Income Dynamics. I show there exists a large transitory component to wages, even after accounting for measurement error. I then show that while wage changes may not be predictable, transitory wage changes predictably disappear. When estimating the labor supply response to these predictable wage changes, I account for serially correlated measurement error and for measurement error that is correlated with true hours and wages. I find almost no correlation between hours worked and predictable wage changes. Therefore, failure to control for measurement error cannot explain the low estimated labor supply elasticities in other papers.
JEL Classification: C51, J22
Suggested Citation: Suggested Citation