Labor Market Institutions, Liquidity Constraints, and Macroeconomic Stability

Frank R. Lichtenberg

NBER Working Paper No. 3926 (Also Reprint No. r2047)
Issued in December 1991
NBER Program(s):Labor Studies

The sensitivity of employment and real wages -- hence aggregate labor income to short-run fluctuations in output varies across countries. We develop a simple theoretical model to show that, if workers, but not capitalists, are liquidity constrained, the sensitivity of an economy to exogenous expenditure shocks is inversely related to the extent to which capitalists, rather than workers, bear fluctuations in income. We perform an econometric test of this proposition using cross-sectional, country-level data on elements of the (time-series) covariance matrix of output, employment, real wages, and investment. We argue that, for two reasons, our estimate of the elasticity of consumption with respect to labor income is likely to be biased towards zero. Nevertheless, our estimate of this parameter is highly significantly different from zero, and is also consistent with previous estimates (obtained from a completely different specification). The empirical results support the view that the lower the sensitivity of labor income to output fluctuations, the smaller the output fluctuations themselves will be. Low sensitivity contributes indirectly as well as directly to the stability of labor income.

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Document Object Identifier (DOI): 10.3386/w3926

Published: Journal of Economic Behavior and Organization, vol. 28, no. 1, (September 1995), pp. 145-154 citation courtesy of

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