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The Frisch labor supply elasticity plays a key role in many economic policy debates, but its magnitude remains controversial. Many studies estimate the Frisch elasticity using 2SLS regressions of hours changes on wage changes. 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 an estimate of 0.60 for young men, but the t-test indicates it is insignificant. In contrast, the Anderson-Rubin (AR) test – which is both optimal and 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 2SLS t-test.

    Authors

    Michael Keane headshot
    Michael P Keane

    Research Associate John Hopkins Carey Business School

    Michael Keane is a Wm. Polk Carey Distinguished Professor at the John Hopkins Carey Business School.

    Working Paper details

    DOI
    10.1920/wp.ifs.2024.4624
    Publisher
    Institute for Fiscal Studies

    Suggested citation

    Keane, M and Neal, T. (2024). Robust inference for the Frisch labor supply. 24/46. London: Institute for Fiscal Studies. Available at: https://ifs.org.uk/publications/robust-inference-frisch-labor-supply (accessed: 13 July 2025).

    Grant

    ESRC Institute for the Microeconomic Analysis of Public Policy 2020-25

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