COWLES FOUNDATION FOR RESEARCH IN ECONOMICS
AT YALE UNIVERSITY

Box 208281
New Haven, CT 06520-8281

COWLES FOUNDATION DISCUSSION PAPER NO. 1090

Unemployment and Liquidity Constraints

Vassilis A. Hajivassiliou and Yannis M. Ioannides

January 1995

In this paper we propose a modelling approach for labor supply and consumption decisions that is firmly grounded within a utility maximizing framework and allows for a role of such institutional constraints as limited access to borrowing and involuntary unemployment. We report estimations for a system of dynamic probit models with data from the Panel Study of Income Dynamics. These estimations test broad predictions of the theoretical model.

One of our models describes a household's propensity to be liquidity constrained in a given period. The second is a dynamic ordered probit model for a labor constraint indicator describing qualitative aspects of the conditions of employment, that is whether the household head is involuntarily overemployed, voluntarily employed, or involuntarily underemployed or unemployed. These models are estimated separately as well as jointly. Our results provide strong support for the basic theory of constrained behavior and the interaction between liquidity constraints and exogenous constraints on labor supply.

Keywords: Intertemporal optimization, Quantity constraints, Liquidity constraints, Unemployment, Dynamic probit models, Simulation estimation

JEL Classification: D91, E24, C61, C33, C35