Econometrics: Quantifying Economic Relationships

There is no doubt that economics is the basis of our world today and, although we do not stop to think about all the economic studies that are performed every day, their presence is undeniable.

We are well aware that topics of this style tend to be tedious for those who are not fans of mathematics, but don't worry, this is understandable.

That’s why if you want to start getting involved in this field or if you want to be aware of how some economic processes work, you should start by familiarizing yourself with some terms.

One that is rarely talked about is econometrics. It doesn't ring a bell, does it?

It's unfortunate that it’s given so little importance considering how relevant it is.

But don't worry, we'll explain what it's all about, where it comes from, what it's for and why we say it's so important:

Definition of econometrics

It’s true that economics as a discipline has existed for several centuries, but the various branches of this specialty have emerged over time.

According to the economic needs of a specific historical moment, analytical techniques have been created to better understand the changes in the economy.

That’s why econometrics is presented as a branch of economics that uses statistical and mathematical methods to analyze and quantify economic relationships.

Therefore, it’s a discipline whose main objective is to model and analyze the relationship between economic variables, which allows economists to make predictions about the future behavior of these variables.

Therefore, through econometrics, it’s possible to analyze variables such as economic growth, inflation, employment, and international trade, among others.

This, at the same time, allows us to evaluate the impact of public policies, such as fiscal stimulus programs, monetary policies, and government regulations.

This means that econometrics is behind all the economic hypotheses and predictions currently being made.

And the reason why many of these inferences end up being fulfilled to the letter is that it’s always studied based on real variables.

A review of its origins...

Now, it should be noted that the term econometrics itself began to be used in 1910 by a number of economists who began to include mathematical statistics in the study of economics.

However, the idea of including both sciences is something that has been proposed since the nineteenth century, but it was not until the twentieth century that it began to be a palpable reality.

Thus, the analysis of economics in conjunction with statistics and mathematics became a reality and began to generate various changes.

From then until today, many theoretical and practical advances in the study of the global economy began to be noticed, which has prepared many governmental systems better to face possible economic crises.

What are the objectives of econometrics?

In order to understand in depth what econometrics is all about, it’s necessary that we take a minute to know the main objectives of this branch of study.

Although it’s true that this branch is currently used for various types of work and analysis, its fundamental objectives can be reduced to two.

On the one hand, there is the projection of the possible economic future, since it’s through econometrics that forecasts of the different macroeconomic variables of a country can be made.

Such is the case of the inflation rate, interest rate increases, and GDP.

In the same way, econometrics is used to estimate causal relationships, but what is this?

It’s all the studies through which a quantitative and qualitative analysis of the variables that interfere in an economic phenomenon is carried out.

This is how studies can be carried out on variables that could have a positive impact on the economy of a country and determine the steps to follow for its correct implementation.

What is econometrics for?

The whole theory of econometrics is undoubtedly very interesting, but its practice is even more interesting.

Although an ordinary citizen does not pay much attention to it, it’s true that it’s a style of analysis that has several functions in the world we live in today.

And the best of all is that such functions always prove to be of great help and preparation to face possible economic problems.

So, in order for you to understand what econometrics is for today, we are going to talk about the different analyses in which it’s applied:

1. Evaluation of public policies

It’s no surprise to anyone that political decisions made in a country can interfere with the country's economy.

That’s why many economists work on the impact of public policies on the economy.

In this area, econometrics is quite useful for assessing the impact of fiscal and monetary policies on the economy, as well as for analyzing the impact of regulatory policies on industry.

In addition, in exceptional political cases, economists who focus on this branch also conduct their analyses to look for possible solutions to problems.

2. Market analysis

On the other hand, within the national and international markets, econometrics also plays an important role.

Through econometrics, market behavior can be analyzed and future market trends can be predicted.

For example, economists can use econometrics to analyze the behavior of prices of goods and services and predict how they will change in the future.

In fact, this is something that was widely used during the pandemic era, when they began to predict the fall in real estate sales, which led to a reduction in real estate prices.

When their costs became very low (and the pandemic was passing), economists were also able to predict in time that sales would increase again, which would also start to increase the prices of goods.

3. Academic Research

At the end of the day, economics is a science that is constantly changing and advancing.

That’s why a branch such as econometrics is also of great help in conducting academic research to develop new theories, formulas or ways to study the economy.

All this is thanks to the analysis of economic data that always drives the development of theoretical models in this field.

4. Business decision making

Last but not least, econometrics is also used in the business sector.

At the end of the day, economics is one of the aspects that has the greatest impact on business decision-making, as it’s directly related to the available capital to be invested.

Thus, a company's economists can apply this branch to analyze company data and make predictions about the company's future behavior.

This, in turn, can help companies make well-informed decisions about production, marketing, and finance.

How does the branch of econometrics work?

Now, we have already gone over enough about the theoretical aspects of this science.

So it’s time to talk essentially about how it actually works.

We are well aware that all of this is laid out in theory, but for econometrics to give good results, it must always be applied correctly.

Therefore, it’s necessary to know briefly what is the methodology through which econometrics works:

1. An initial economic hypothesis

The first step of all is to establish the economic hypothesis on which the whole analysis will be based in order to determine what the object of study will be and which variables will be taken into account for the study.

2. The formulation of the econometric model

Next, it’s time to establish the econometric model to be implemented.

Depending on the case and the variables to be studied, the model in question may vary.

On this point, two types of models can be recognized: the dependent and the independent.

In the first one, the variables will depend on each other and in the second one the variables are unique and individual.

3. Estimating the unknown parameters

Now it’s time to estimate the unknown parameters that may interfere with the economic phenomenon under study.

In order to establish them, it will be necessary to work with estimation methods and resort to empirical data.

4. Validate and apply the model

After all this, the econometric model needs to be validated, otherwise, it will not be possible to move forward with the analysis.

At this point, statistical inference must be applied to decide whether the model can be applied to the economic hypothesis or not.

If yes, then the exploitation of the model should be carried out to start with the analysis as such.

Once this is done, a series of data will be available as results that should be used for the predictions to be made about the variables.

5. Applying the results from an analytical perspective

Finally, it will all be a matter of correctly applying the results to perform the analysis and prediction of the possible economic changes that will take place.

It’s in this way that econometrics works to anticipate everything that can happen in the different areas in which economics is applied.

What is the importance of econometrics today?

Now that you have a complete idea of what econometrics is, what it is for, and how it works, you will have no doubt about how important it is.

Without it, it would be impossible to predict the future behavior of the economy and evaluate the impact of public policies on the economy.

In addition, we must not forget how fundamental this branch is also for the business sector and the preparation that companies have when it comes to managing the economic aspect.

The impact of this type of analysis is so great that it can even help companies make informed decisions about production, marketing, and finance.

All this and much more makes econometrics so applied and so important to the world we live in today.

What are the concepts to be handled when working with econometrics?

Since this branch brings together economic, statistical, and mathematical aspects, it’s not surprising that it brings together a wide variety of concepts that must be clear for the development of these analyses.

Of course, if you are a beginner in this field, you need these terminologies to be able to understand the internal processes of econometrics.

So, we recommend that you familiarize yourself with the following list of econometric terms:

• Linear regression.

• Endogenous and exogenous variables.

• Discrete choice models.

• Time series analysis.

• Hypothesis testing.

Now that you have a more complete perception of econometrics, you are ready to understand in depth everything that is done with it.

Moreover, its presence in areas as important as business is often the basis of many processes, since you must be prepared for possible changes that can be made in terms of the economy.

And you, did you already know what econometrics is? If so, is everything clear to you? In the comments section, you can leave us your opinion, it’s of great interest to us.