Since the inception of the idea of econometrics, many economic analysts have used its model to explain the interrelatedness of fundamental economic factors. These factors include labor, capital, interest rates, as well as government’s fiscal and monetary policies. Econometricians use a ton of data available to them to analyze these simple relationships.
But, does it stop at that? From keen studies, econometrics serves other purposes which strengthen the economic systems. And, these are explained further in this article.
Introduction to Econometrics
Econometrics is the quantitative application of statistical and mathematical data, models, and theories to develop new economic theories, test existing hypotheses, and forecast future trends.
It seeks to transform real-world data into statistical hypotheses and then describes the results with the theory or theories in view for common grounds. This means that these economic models are converted to tools for economic policymaking.
In their book, Stock and Watson wrote “Econometric methods are used in many branches of economics, including finance, labor economics, macroeconomics, microeconomics, and economic policy.”
Econometrics converts qualitative statements into quantitative ones. For instance, describing the positive relationship between two variables, econometrics says: “with every one dollar increase in disposable income, consumers’ spending increases by 90 cents”. This shows that it uses numbers rather than concepts or theories to explain phenomena.
Ragnar Frisch, Lawrence Klein, and Simon Kuznets are the pioneers of econometrics for which they won the Nobel Prize in 1971.
What are the Types of Econometrics
Econometrics has two major divisions depending on what the analyst seeks to achieve.
Theoretical Econometrics studies existing statistical models to discover their properties and their values. This is relevant in developing new statistical procedures, useful in the field of economics, and are not subject to changes in data.
Applied Econometrics is focused on converting qualitative economic statements into quantitative statements using econometric techniques. It concerns itself with topics around the production of goods, demand for labor, arbitrage pricing theory, and more. And, because of the variance of the data, applied econometrics changes with time.
The Need for Econometrics
The foremost windfall of econometrics is to test economic theories or hypotheses provided by econometricians. The direct relationship between consumption and income or the effect of the quantity demanded of a certain commodity and its price can be tested using econometric.
Secondly, econometrics provides a means to derive numerical estimates for the variables of economic relationships. These numerical estimates are vital for reaching economic-related decisions. For instance, a valid estimate of the coefficient of the relationship between income and consumption is a fundamental tool for policy-making. A policymaker will need them to understand the possible outcome of a proposed tax reduction for instance and make an informed decision.
Lastly, econometrics is pertinent to forecast future economic trends which is also a key tool for effective policy-making. If according to predictions there is a high tendency of low inflation in the future, policymakers can be proactive in their decisions.
So, in all, econometrics can help financiers and economists by making the best financial decisions.
Econometrics facilitate the testing of statistical models, the development of new theories, and the making of inferences. Policy-makers need these inferences to form policies and make crucial decisions.