What is econometrics?

Every year, IMF releases its quarterly magazine Finance and Development. Apart from a broad theme, there is a section called Back to Basics which looks at some key economic issues/concepts. IMF has just put up a link where all the previous back to basics columns have been listed.

In Dec-11 edition, back to basics discussed this topic -What is econometrics? It is written by Sam Ouliaris.

What does ecotrics (as called by most) help in?

Econometrics uses economic theory, mathematics, and statistical inference to quantify economic phenomena. In other words, it turns theoretical economic models into useful tools for economic policymaking. The objective of econometrics is to convert qualitative statements (such as “the relationship between two or more variables is positive”) into quantitative statements (such as “consumption expenditure increases by 95 cents for every one dollar increase in disposable income”). Econometricians—practitioners of econometrics—transform models developed by economic theorists into versions that can be estimated. As Stock and Watson (2007) put it, “econometric methods are used in many branches of economics, including finance, labor economics, macroeconomics, microeconomics, and economic policy.” Economic policy decisions are rarely made without econometric analysis to assess their impact.

He says ecotrics can be divided into two types – theoretical and applied.  Theoretical guys look at techniques used in the subject whereas empirical guys use the tools developed by theoretical guys.

Econometrics can be divided into theoretical and applied components.

Theoretical econometricians investigate the properties of existing statistical tests and procedures for estimating unknowns in the model. They also seek to develop new statistical procedures that are valid (or robust) despite the peculiarities of economic data—such as their tendency to change simultaneously. Theoretical econometrics relies heavily on mathematics, theoretical statistics, and numerical methods to prove that the new procedures have the ability to draw correct inferences.

Applied econometricians, by contrast, use econometric techniques developed by the theorists to translate qualitative economic statements into quantitative ones. Because applied econometricians are closer to the data, they often run into—and alert their theoretical counterparts to—data attributes that lead to problems with existing estimation techniques. For example, the econometrician might discover that the variance of the data (how much individual values in a series differ from the overall average) is changing over time. 

In a way most economists are applied as they test their ideas but only a few remain theoretical ones.  Someone like Chris Sims is more like a theoretical econometrician whereas others who use his VAR model are the applied types. So when you study economics at higher levels, you may not opt for a theoretical application of econometrics but appplications of the tools is highly desired.

He goes on to explain how an economic model is translated into an econometric exercise.

A nice explanation. Though one can definitely say – “Easier said than done”.

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