Econometrics is the application of mathematical and statistical methods to describe economic systems. It also involves using mathematical and statistical theories to test hypotheses and predict future trends. It uses mathematics, statistical inference, and economic theory to quantify economic phenomena.
Economists say that econometrics turns theoretical economic models into tools that lawmakers, i.e., policymakers, can use for policymaking.
Econometrics converts qualitative statements into quantitative statements. Let’s look, for example, at the qualitative statement: “The relationship between two variables is positive.” Econometrics converts it to: “Consumer spending rises by 90 cents for ever single dollar increase in disposable income.”
Econometricians convert models that economic theorists developed into versions with which we can make estimates.
BusinessDictionary.com has the following definition of the term:
“[It is the] application of statistical techniques in evaluation and testing of economic theories.”
“It uses econometric modeling to explain relationships between key economic factors such as capital, labor, interest rates, and government’s fiscal and monetary policies.”
Econometricians sift through piles of data to extract simple relationships.
Econometrics – etymology
Paweł Ciompa, a Polish economist, first used the term in cognate form in 1910.
However, economists say that Ragnar Frisch (1895-1973) coined the term in the sense with which we use it today.
Frisch, a Norwegian economist, was the 1969 co-recipient of the Nobel Memorial Prize in Economic Sciences. We also call it the Nobel Prize for Economics.
Economists say that Frisch and Jan Tinbergen (1903-1994) were the founders of econometrics. Tinbergen, the other 1969 Nobel Prize co-recipient, was an important Dutch economist.
Econometrics – two components
We divide econometrics into two components: 1. Theoretical. 2. Applied.
A theoretical econometrician investigates the properties of current statistical procedures and tests for estimating unknowns in the model.
Despite the peculiarities within the economic data, theoretical econometricians try to develop new statistical procedures. Specifically, they develop procedures that are robust or valid.
According to the International Monetary Fund (IMF):
“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, on the other hand, use the techniques that the theorists developed. They use them to translate qualitative economic statements into quantitative ones.
As they are closer to the data, applied econometricians run into data attributes that mess up existing estimation techniques. They tell their theoretical counterparts when this happens.
They might find that, for example, the variance of the data is changing as time passes. Individual values differing significantly from the overall average is an example of data variance.
Video – What is econometrics?
This Keynes Academy video explains what the term means, what its goals are, and types of economic data. It also explains what ‘Simple Linear Regression’ is.