The econometric dream-world

from Lars Syll

Trygve Haavelmo — with the completion (in 1958) of the twenty-fifth volume of Econometrica — assessed the role of econometrics in the advancement of economics, and although mainly positive of the “repair work” and “clearing-up work” done, he also found some grounds for despair:

We have found certain general principles which would seem to make good sense. Essentially, these principles are based on the reasonable idea that, if an economic model is in fact “correct” or “true,” we can say something a priori about the way in which the data emerging from it must behave. We can say something, a priori, about whether it is theoretically possible to estimate the parameters involved. And we can decide, a priori, what the proper estimation procedure should be … But the concrete results of these efforts have often been a seemingly lower degree of accuracy of the would-be economic laws (i.e., larger residuals), or coefficients that seem a priori less reasonable than those obtained by using cruder or clearly inconsistent methods.

There is the possibility that the more stringent methods we have been striving to develop have actually opened our eyes to recognize a plain fact: viz., that the “laws” of economics are not very accurate in the sense of a close fit, and that we have been living in a dream-world of large but somewhat superficial or spurious correlations.

Another of the founding fathers of modern probabilistic econometrics, Ragnar Frisch, shared Haavelmo’s doubts on the applicability of econometrics:

I have personally always been skeptical of the possibility of making macroeconomic predictions about the development that will follow on the basis of given initial conditions … I have believed that the analytical work will give higher yields – now and in the near future – if they become applied in macroeconomic decision models where the line of thought is the following: “If this or that policy is made, and these conditions are met in the period under consideration, probably a tendency to go in this or that direction is created”.

Ragnar Frisch

Econometrics may be an informative tool for research. But if its practitioners do not investigate and make an effort to provide a justification for the credibility of the assumptions on which they erect their building, it will not fulfil its tasks. There is a gap between its aspirations and its accomplishments. Without more supportive evidence to substantiate its claims, critics will continue to consider its ultimate argument as a mixture of rather unhelpful metaphors and metaphysics. Maintaining economics should be a science in the ‘true knowledge’ business, yours truly remains a sceptic of the pretences and aspirations of econometrics. So far, I cannot really see that it has yielded very much in terms of relevant, interesting economic knowledge.

The marginal return on its ever-higher technical sophistication in no way makes up for the lack of serious under-labouring of its deeper philosophical and methodological foundations that already Keynes complained about. The rather one-sided emphasis of usefulness and its concomitant instrumentalist justification cannot hide that the legions of probabilistic econometricians who give supportive evidence for their considering it “fruitful to believe” in the possibility of treating unique economic data as the observable results of random drawings from an imaginary sampling of an imaginary population, are skating on thin ice. After years having analyzed ts ontological and epistemological foundations, I cannot but conclude that econometrics on the whole has not delivered ‘truth,’ nor robust forecasts.