Econometrics and equilibrium models

ABSTRACT

In Rational Econometric Man, Edward Nell and Karim Errouaki present a welcome and timely case for the view that econometrics and econometric model-building may not be the magic tools to solve all empirical questions despite what many seem to have thought they were in the 1960s. Here I examine some possible problems with econometric models that have to do with their usually taking the form of equilibrium models. Some of these problems were recognized by Trygve Haavelmo decades ago. And as Aris Spanos has recently discussed, the problems are often the result of what we say in our textbooks. Some problems have to do with what we mean by econometric parameters and others with how we use probabilities.

KEYWORDS:

• Econometrics
• equilibrium
• models
• parameters
• probabilities

Disclosure statement

No potential conflict of interest was reported by the author.

Notes

¹Before going on, we need to call attention to the fact that textbooks are routinely misleading about necessary and sufficient conditions. For an elementary example, consider the theory of the firm. We say that a necessary condition for profit maximization is that marginal revenue equals marginal cost, so that the slope of the profit function is zero. In order to distinguish a maximum from a minimum, it is further necessary that the second derivative of the profit function be negative at the point of optimization. Unfortunately, textbooks sometimes identify the secondary diminishing margin as the sufficient condition for maximization. But there is no sufficient condition. The diminishing margin condition is also a necessary condition of maximization. We should say that the conjunction of the two necessary conditions is the sufficient condition.

²P.A.V. Swamy (1970) has proposed a way to deal with non-ergodic parameters in econometric models, but not much has been done with his proposal judging by today's econometrics textbooks.