Econometrics

Econometrics is the use of statistical and mathematical models to develop theories or test existing hypotheses in economics and to forecast future trends from historical data. It subjects real-world data to statistical trials and then compares the results against the theory being tested.

Depending on whether you are interested in testing an existing theory or in using existing data to develop a new hypothesis, econometrics can be subdivided into two major categories: theoretical and applied. Those who routinely engage in this practice are commonly known as econometricians.

Limitations of Econometrics

Econometrics is sometimes criticized for relying too heavily on the interpretation of raw data without linking it to established economic theory or looking for causal mechanisms. It is crucial that the findings revealed in the data are able to be adequately explained by a theory, even if that means developing your own theory of the underlying processes.

Regression analysis also does not prove causation, and just because two data sets show an association, it may be spurious. For example, drowning deaths in swimming pools increase with GDP. Does a growing economy cause people to drown? This is unlikely, but perhaps more people buy pools when the economy is booming. Econometrics is largely concerned with correlation analysis, and it is important to remember that correlation does not equal causation.