Real business cycle and DSGE models must calibrate the Frisch (intertemporal-substitution) elasticity of labor supply at roughly 2-4, or effectively unbounded under indivisible labor, to reproduce observed fluctuations in aggregate hours, while microeconometric estimates cluster near 0-0.5 and a bias-corrected meta-analysis finds the extensive-margin literature consistent with a mean near zero. The literature offers partial, mutually inconsistent reconciliations - aggregation across heterogeneous workers and margins (Erosa-Fuster-Kambourov; Chang-Kim-Kwon-Rogerson; Yum), optimization frictions (Chetty), human capital and dynamic returns (Keane-Rogerson; Kleven et al.), and measurement corrections in both directions (Elminejad et al.; Keane-Neal) - but directly measured extensive-margin curves (Mui-Schoefer) are still not matched by existing models, and no consensus decomposition of the gap or calibration recommendation exists. The problem of quantitatively explaining the gap and settling what macro models should calibrate remains open.

Background

Real business cycle (RBC) and dynamic stochastic general equilibrium (DSGE) models - the workhorse frameworks for analyzing business-cycle fluctuations and counterfactual policy - must assign a value to the Frisch elasticity of labor supply: the percentage change in hours worked in response to a transitory (temporary) wage change, holding the marginal utility of wealth fixed (the utility value of an extra dollar of income, which is constant along a worker's optimal intertemporal plan). The RBC tradition initiated by Hansen (1985) and Rogerson (1988) introduced indivisible labor - employment modeled as all-or-nothing rather than freely chosen hours - with lotteries in which workers insure each other over who works; under this device the aggregate Frisch elasticity becomes effectively infinite, letting the model reproduce the observed volatility of aggregate hours over the business cycle. Calibrated models that instead keep hours choice convex typically need Frisch elasticities of roughly 2-4 for the same purpose. Two related concepts must be distinguished: the Frisch elasticity, relevant for responses to transitory wage fluctuations, and the Hicksian (compensated) steady-state elasticity, relevant for long-run comparisons such as cross-country differences in labor supply caused by tax systems. Responses also operate on two margins: the intensive margin (small adjustments in hours per employed worker) and the extensive margin (entering or leaving employment). Microeconometric studies - largely on prime-age men at the intensive margin, using quasi-experimental or instrument-based designs (natural experiments and instrumental-variable methods that exploit policy or wage variation to identify causal responses) - usually estimate Frisch elasticities near 0-0.5. Chetty, Guren, Manoli, and Weber (2011) synthesized the evidence on both margins and concluded that micro estimates are consistent with macro steady-state Hicksian elasticities for cross-country comparisons, but that micro estimates of the Frisch elasticity are an order of magnitude smaller than the values needed to explain business-cycle fluctuations in aggregate hours by preferences alone, leaving as 'the key puzzle to be resolved' why micro and macro estimates of the Frisch extensive-margin elasticity are so different. Ljungqvist and Sargent (2011) asked whether an 'accord' on the aggregate elasticity is possible: replacing the RBC aggregation theory with a life-cycle theory of labor supply (as in Prescott, Rogerson, and Wallenius 2009, where workers choose workweek length over their lifetime) makes the implied macro elasticity depend on how shocks and government institutions place workers at interior solutions for career length (interior solutions meaning non-corner optimal choices, here career lengths strictly between the shortest and longest feasible). Keane and Rogerson (2012) argued that small micro estimates are fully consistent with large aggregate elasticities once human-capital accumulation and extensive-margin participation are modeled. Chetty (2012) showed that small optimization frictions (adjustment costs or inattention, which make observed responses understate structural preferences) can reconcile small intensive-margin estimates with larger structural elasticities, estimating a Hicksian elasticity of 0.33 intensive and 0.25 extensive. On the measurement side, Havranek, Horvath, and Elminejad (2021; published as Elminejad, Havranek, Horvath, and Irsova 2023) meta-analyzed 723 estimates from 36 studies and attributed half of the reported extensive-margin mean of 0.5 to publication bias (larger estimates reported preferentially) and half to identification bias (less exogenous wage variation producing larger estimates), implying a bias-corrected mean near zero, while Keane and Neal (2021; 2025) argue that near-zero micro two-stage least squares (2SLS, an instrumental-variable estimation method) estimates are artifacts of weak instruments (instruments only weakly correlated with the wage, which bias the estimates toward the plain ordinary-least-squares correlation while shrinking their standard errors). No reconciliation has gained consensus, and the question of what a macro model should actually calibrate remains actively debated.

Problem Statement

Explain, with a quantitatively disciplined account, why microeconometric estimates of the Frisch (intertemporal-substitution) elasticity of labor supply - clustered near 0-0.5, and possibly near zero after correction for publication and identification bias - are roughly an order of magnitude smaller than the values that RBC/DSGE business-cycle models must calibrate (about 2-4, or effectively unbounded under Hansen-Rogerson indivisible labor) to reproduce observed fluctuations in aggregate hours. The account should decompose the gap among the candidate channels - genuine aggregation across heterogeneous workers and margins (extensive-margin participation, life-cycle and career-length decisions, human-capital accumulation, nonlinear wages), mismeasurement of micro estimates (weak instruments, publication and identification bias, optimization frictions), and macro model misspecification; determine what elasticity concept and value a macro model should calibrate for each use, distinguishing at minimum business-cycle (Frisch) from long-run policy (Hicksian) applications; and remain consistent with both bodies of evidence, identifying which margin, horizon, and elasticity concept each targeted estimate measures. This is the open question stated by Chetty, Guren, Manoli, and Weber (2011) - 'why micro and macro estimates of the Frisch extensive margin elasticity are so different' - together with the accord question of Ljungqvist and Sargent (2011) and the calibration question emphasized by Keane and Rogerson (2012).

References

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