What is econometrics? The clue is in the word itself: “econo” refers to its relation to economics; “metrics” suggests the science of empirical measurement. Thus, econometrics applies statistical methods that describe real-world phenomena and creates testable economic models.
Econometrics is a subset of economics, applying statistics and mathematical techniques to “justify” a theoretical economic model with empirical rigor. In other words, econometrics transforms the often arcane discipline of theoretical economics into policy and decision-making tools in the public and private sectors.
Let’s dig in.
Economic Model vs. Econometric Model
Economic models are “simplifications of the real world that we use to understand the behavior and relations between different economic agents,” says Jose Fillat, Senior Economist and Policy Advisor at the Federal Reserve Bank of Boston. Fillat holds a Ph.D. in economics and is also a professor for the Master of Science in Applied Economics program at Boston College.
“For example,” he says, “we need economic models to understand how consumers decide to buy a car today or save the money and buy the car next year. Or to understand how consumers decide between a fixed-rate mortgage versus a variable rate mortgage.” Understanding the “economic mechanism,” explains Fillat, is fundamental for further evaluating the potential impact of a proposed policy change. Here is where econometrics comes into play.
We can best illustrate this with an example.
Modeling Electric Car Subsidies: Qualify Then Quantify to Justify
Consider, for instance, the impact of air pollution under a government subsidy for electric car purchases.
We first build an economic model theorizing the variables of this policy proposal:
- Will people feel incentivized to buy electric cars when offered a subsidy?
- If so, what is the expected impact on air pollution?
- If not, why not? (i.e., lack of recharging stations, limited range of the cars, etc.)
- How will a subsidy on electric cars influence the auto manufacturing sector and the economy as a whole?
These questions (and vastly many more) qualify an economic model. But how do we justify any conclusions from this model? We do so by using statistical and mathematical processes quantifying all our variables with an econometric model. “Econometric models help us assess the validity of the economic models that economic theory develops,” Fillat says.
“An economic model,” adds Nathaniel Bastian, also an adjunct professor in Boston College’s MSAE program, “connects the variables and how they relate.” From the “hypothetical construct of that economic model,” the mathematical and statistical regimen of econometrics creates an empirical model. “Think data-driven,” says Bastian.
“I want to estimate and test the relationship between the variables that make up that economic model,” he says. “I want to be able to make some sort of statistical inference from them. Econometrics is the statistical theory and mathematical modeling used to test economics models.”
Whether for our electric car subsidy example, determining insurance rates for drivers, calculating the likely success of a baseball team’s next season, or any economic question, econometrics is the tool used to test and quantify the answer.
How do we develop the mathematical models we employ in econometrics?
Theoretical vs. Applied Econometrics
The distinction between theoretical and applied econometrics is indistinct and debatable. Bastian describes theoretical econometrics as determining the “appropriate methods for measuring economic relationships.”
On the other hand, applied econometrics is “when we apply those econometric methods to problems,” he says. Here, Bastian gets to the core beauty of economics and, consequently, econometrics.
Economics describes more than fiscal policy but how society functions. The interactions of all the variables of a diverse and complex social structure. An equitable, sustainable society, including its component parts, depends on a viable economic model.
With econometrics, we have a tool for applying economic models to real problems. Econometrics is the cornerstone of applied economics.
Learn Econometrics and Applied Economics at Boston College
The online Master of Science in Applied Economics degree program from Boston College is for students ready for the challenge of helping solve problems in a complicated world.
The groundbreaking program prepares graduates for a career in data analysis and interpretation across a variety of sectors.
On Theory and Practice
It’s important to know the theory, Bastian says, “but it’s more important to know the tools and the methods and how to apply them.” The MSAE program emphasizes the real-world application of economics. Without this, frankly, economics is bootless for all the reasons we’ve previously described. Theory serves practice.
Any model is only as good as its data. “In the BCMSAE courses,” says Jose Fillat, “students need to deal with real-world data. They have to deal with the cleaning stages and arranging it in a way that is ready for the analysis.” Students get their hands dirty.
In Fillat’s banking course, for instance, students estimate the credit risk of a portfolio. “My students run a stress testing exercise very similar to how banks run them in real-life,” he says. “It is an extraordinary challenge, but students come out prepared to have real-life conversations with hiring managers, way beyond the textbook examples that all candidates will have, and that’s what sets them apart.
Course of Study in Applied Economics
The curriculum offers students the theory and practical knowledge to assume leading roles in any industry or organization.
- Fundamental theory
- Data analysis
- Law and economics
- Ethics and public policy
- Behavioral economics
Earning the MSAE degree requires completing five core and five elective courses. Students can choose among 26 elective courses to hone their knowledge toward their specific interests and passion.
Boston College also offers an online Graduate Certificate in Data Analytics program specifically focused on data analytics, econometrics, big data econometrics, and predictive analysis.
What is econometrics? It is the best tool we have for applying economics to the healthy interactions of a complex society. From it, we can imagine a better future, not based on assumptions and hypotheses, but from testable models. The MSAE and data analysis certificate programs will open the door to your future. You can help make a better world.