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 nd 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.