Critiques of Econometrics

Econometrics has its critics. Interestingly, John Maynard Keynes (1940, p. 156) had the following to say about Jan Tinbergen’s (1939) pioneering work:

No one could be more frank, more painstaking, more free of subjective bias or parti pris than Professor Tinbergen. There is no one, therefore, so far as human qualities go, whom it would be safer to trust with black magic. That there is anyone I would trust with it at the present stage or that this brand of statistical alchemy is ripe to become a branch of science, I am not yet persuaded. But Newton, Boyle and Locke all played with alchemy. So let him continue.4

In 1969, Jan Tinbergen shared the first Nobel Prize in economics with Ragnar Frisch.

Well cited critiques of econometrics include the Lucas (1976) critique which is based on the Rational Expectations Hypothesis (REH). As Pesaran (1990, p. 17) puts it:

The message of the REH for econometrics was clear. By postulating that economic agents form their expectations endogenously on the basis of the true model of the economy and a correct understanding of the processes generating exogenous variables of the model, including government policy, the REH raised serious doubts about the invariance of the structural parameters of the mainstream macroeconometric models in face of changes in (government policy.

Responses to this critique include Pesaran (1987). Other lively debates among econometricians include Ed Leamer’s (1983) article entitled “Let’s Take the Con Out of Econometrics,” and the response by McAleer, Pagan and Volker (1985). Rather than leave the reader with criticisms of econometrics especially before we embark on the journey to learn the tools of the trade, we conclude this section with the following quote from Pesaran (1990, pp. 25-26):

There is no doubt that econometrics is subject to important limitations, which stem largely from the incompleteness of the economic theory and the non-experimental nature of economic data. But these limitations should not distract us from recog­nizing the fundamental role that econometrics has come to play in the development of economics as a scientific discipline. It may not be possible conclusively to re­ject economic theories by means of econometric methods, but it does not mean that nothing useful can be learned from attempts at testing particular formulations of a given theory against (possible) rival alternatives. Similarly, the fact that economet­ric modelling is inevitably subject to the problem of specification searches does not mean that the whole activity is pointless. Econometric models are important tools for forecasting and policy analysis, and it is unlikely that they will be discarded in the future. The challenge is to recognize their limitations and to work towards turning them into more reliable and effective tools. There seem to be no viable alternatives.

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