Econometric lamppost methodology3 December, 2016 at 11:28 | Posted in Statistics & Econometrics | 1 Comment
Individuals, households and firms behave so irrationally and their behaviour in groups is so little understood that it is hard to think of an economic law with any claim to universality. This is a strong statement. If the statement is true, this is unfortunate, not only for its own sake, but also because of its consequences. Let me briefly discuss one consequence of a universal law. The example is a very famous one taken from physics, a discipline where everything is easier than in applied econometrics, and it shows that when one law is right it can be used to find another one.
If we observe the moons of Jupiter over a long period of time, we discover that the moons are sometimes eight minutes ahead of time and sometimes eight minutes behind time where the time is calculated according to Newton’s laws. We also discover that the moons are ahead of time when Jupiter is close to the earth and behind when Jupiter is far away. If we believe Newton, then we must conclude that it takes light some time to travel from the moons of Jupiter to the earth and what we are looking at when we see the moons is not how they are now but how they were the time ago it took the light to get here. Olaus Rømer thus demonstrated in 1675 that light has a finite speed and one year later he estimated that speed at 214,300 km/s, a remarkable achievement, only about 30% too low.
Nothing of such sweeping beauty would ever be possible in econometrics. This is because people, firms, organizations, and their interactions at various levels of aggregation are so much richer and more interesting than planets and therefore, inevitably, much more difficult to model and predict …
Fortunately, there is still a lot of work to be done. Econometrics has had wonderful successes and econometric theory has developed with terrific speed and depth. Nevertheless, we have not been searching for the keys where we expect them to be. So, we find all sorts of interesting things under the lamppost: a coin, a piece of string, and so on, things that we proudly report on in our research papers, but we do not find the keys. This is depressing. There is only one solution, namely to move the lamppost. That done, econometricians can continue to make important contributions and eventually, perhaps, become respectable scientists.