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What is an Econometric Model?

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  • Written By: Mike Howells
  • Edited By: Allegra J. Lingo
  • Last Modified Date: 10 September 2016
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Economists often rely on econometrics to predict future trends, which in a very broad sense is the application of statistical analysis to economic data. One of the core tools of this discipline is the econometric model. In a basic sense, econometric modeling is used to establish and then test a predictable relationship between two economic factors, such as how income affects spending.

Econometrics first emerged in the 1930s as the brainchild of Norwegian economist Ragnar Frisch. Frisch was the first to bring elements of statistical analysis to economic study, and believed that they could help lend a greater degree of confidence to economic forecasting. Among his particular contributions to the field was the introduction of linear regression modeling, which became a classic econometric model.

At its core, an econometric model offers empirical analysis to a field of study that traditionally has resisted such scrutiny. A variety of different econometric methods have been developed to help analysts offer statistically significant guidance on economic phenomena. One of the core conceits of econometric modeling is that it is an uncertain science because it relies so greatly on human behavior. Every econometric model, therefore, incorporates some degree of probability in its formulation.

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In creating a typical econometric model, an economist must first be clear on what he wants the model to show. Commonly, it is the impact of one factor on another. The next step is recording data and measurements on a given set of variables to generate what is known as a dataset. This data may be a worker's earnings over a period of time, a country's Gross Domestic Product (GDP), interest rates offered by a central bank, or any other information of interest based on the goal of the model.

Once an economist is satisfied with the data that has been collected, he can begin to manipulate it and leverage the model to produce usable results. These results are subjected to scrutiny and judged by peers. Good models emerge as the ones that stand up to inquiry and are shown to reproduce reliable, realistic data again and again.

Increasingly, the use of econometric models has been adopted by policy-makers to help guide fiscal management strategies. Governments and central banks utilize, and pay handsomely for, econometric data. As with many political endeavors, it is not uncommon for observers and economists to accuse government officials of using data supportive of their preexisting opinions, rather than letting the data guide them to a new conclusion.

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