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Econometrics: Methodological Issues

This entry reviews the major methodological debates that shaped the field of econometrics by unifying statistics and economics and explains the roles of causality (and probability) and of modeling in econometrics.

In the 1920s, Ragnar Frisch coined the term econometrics as the unification of statistics, economic theory, and mathematics to turn economics into a science. Because most current economic theories are expressed in a mathematical language, the constituent mathematics is not considered anymore to be part of modern econometrics. The aim of econometrics is generally conceived as Trygve Haavelmo defined it to be, namely, a conjunction of economic theory and measurement, using the theory and technique of statistical inference as a bridge pier. But current econometricians emphasize that economies are so highly dimensional, nonstationary, and complicated that economic theory can never precisely specify the underlying process. So a commonly held view today is that econometrics is synonymous with economic statistics.

Methodological Debates

Since its origin in the 1930s, subsequent debates shaped the ideas of what econometrics entails, or is supposed to entail.

The Keynes-Tinbergen Debate

The first two macroeconometric models were constructed by Jan Tinbergen in the late 1930s. The second model was built when Tinbergen was commissioned by the League of Nations to perform statistical tests on business-cycle theories. Tinbergen's new method of econometric testing provoked a great deal of controversy. It was John Maynard Keynes's critique of “Tinbergen's method” that sparked off the debate about the role of econometrics and what it might be able to achieve.

According to Keynes, the technique of multiple correlation analysis that had been adopted by Tinbergen was solely a method for measurement. It contributed nothing in terms of either discovery or criticism. The implication was that if the economic theorist does not provide the modeler with a complete set of causal factors, then the measurement of the other causal factors will be biased. Moreover, Keynes argued that some significant factors in any economy are not capable of measurement or may be interdependent.

The “Measurement without Theory” Debate

Another early econometric debate in the 1940s started with Tjalling C. Koopmans's book review of Measuring Business Cycles, by Arthur F. Burns and Wesley C. Mitchell, published by the National Bureau of Economic Research (NBER). Koopmans's critique was based on Haavelmo's “Probability Approach.” In fact, he was defending the Cowles Commission's (CC) structural equation approach against the NBER's “empiricist position.” He accused Burns and Mitchell of trying to measure economic cycles in the absence of any economic theory about the workings of such cycles. According to the CC approach, economic variables are determined by the simultaneous validity of a large number of structural equations describing behavior and technology. Any observed empirical regularity between a number of variables may be the result of the working of several simultaneous structural relations. Because so many empirical relations are valid simultaneously, it may be difficult—or even impossible—to uncover the more fundamental structural relationships. In the absence of experimentation, the identification of these structural relations is possible only if the set of variables involved in each equation, and the manner in which they are combined, is specified by economic theory.

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