Time Series Econometrics and Applied Economics: A Methodological Perspective

Article excerpt

Many applied economists face problems in selecting an appropriate technique to estimate short and long run relationships with the time series methods. This paper reviews three alternative approaches viz., general to specific (GETS), vector autoregressions (VAR) and the vector error correction models (VECM). As in other methodological controversies, it is hard to say which one is the best. It is suggested that if these techniques are seen as tools to summarize data, as in Smith (2000), often there may be only minor differences in their estimates. Therefore, a computationally attractive technique is likely to be popular. Finally, we also explain that GETS is a simple and useful technique to understand some dicult choices in the VECM technique of Johansen.

JEL Classification: C230, C510, C520, C590.

Keywords: General to Specific Models, Cointegration, VAR Models, Alternative Methods, Short and Long Run Equations.

INTRODUCTION

There is hardly any applied economic work without some applied econometrics: However, often applied economists lose their economic perspective and digress into demonstrating their econometric skills. Underlying this trend is a belief that economics is more scientific than it actually is, and the accuracy of our explanations can be dramatically improved by using the latest econometric techniques and software. It is necessary, therefore, to have a good perspective of what we do as applied economists and to what extent econometric techniques and, in particular, time series techniques are useful.

We follow Smith (2000) and distinguish between three stages in applied economic research viz., (1) purpose, (2) summary and (3) interpretation. Within this threefold classification, econometric techniques are tools to provide summaries of data. Reliable and qualitatively unambiguous summaries are useful for interpretation and examine if they serve the purpose. Therefore, in the day to day applied economic work there is more than just preparing summaries of facts with alternative econometric techniques. The latest econometric techniques may improve the accuracy of these summaries and at times only marginally e.g., improving a t-ratio from 1.9 to 2.0, but it is doubtful if such improvements alone are adequate and more important than the other two objectives in applied research. Nevertheless, it is desirable to use more than one technique to find if alternative techniques give similar or conflicting quantitative or qualitative summaries of the same set of facts. If they all yield similar summaries, with minor dierences, that increases ones confidence in their usefulness.

Given that there are alternative procedures, options and more than one time series technique to use, e.g., testing for unit roots and estimating cointegrating equations, applied economists often forget the first and last objectives in Smith's threefold classification and digress into endlessly using alternative econometric techniques with the expectation that these techniques provide definite answers to issues that fall into the other two stages in applied economic work. Smith (2006) says that there are about 100 options in EViews 5 (2004) to estimate cointegrating equations and it is dicult to decide which is the best. Furthermore, it is not uncommon for journals to reject papers because they did not use the latest econometric technique or a less frequently used technique developed by a referee. One may be excused for saying that the economics profession has become like a firm that endlessly produces improved prototype products, without ever producing a finished product for the market. The declining enrollments in economics courses is an indication of this trend. In this paper we shall look into some popular time series techniques with these perspectives with a view to develop a few pragmatic methodological alternatives for the applied economists.

Two developments have changed the way applied economists have been using econometric techniques. …