what is econometrics 
econometrics is the use of statistical and mathematical models to develop theories or test existing hypotheses in economics and to forecast future trends from historical data it subjects real world data to statistical trials and then compares the results against the theory being tested depending on whether you are interested in testing an existing theory or in using existing data to develop a new hypothesis econometrics can be subdivided into two major categories theoretical and applied those who routinely engage in this practice are commonly known as econometricians investopedia michela buttignolunderstanding econometricseconometrics analyzes data using statistical methods in order to test or develop economic theory these methods rely on statistical inferences to quantify and analyze economic theories by leveraging tools such as frequency distributions probability and probability distributions statistical inference correlation analysis simple and multiple regression analysis simultaneous equations models and time series methods econometrics was pioneered by lawrence klein ragnar frisch and simon kuznets all three won the nobel prize in economics for their contributions 123 today it is used regularly among academics as well as practitioners such as wall street traders and analysts an example of the application of econometrics is to study the income effect using observable data an economist may hypothesize that as a person increases their income their spending will also increase if the data show that such an association is present a regression analysis can then be conducted to understand the strength of the relationship between income and consumption and whether or not that relationship is statistically significant that is it appears to be unlikely that it is due to chance alone methods of econometricsthe first step to econometric methodology is to obtain and analyze a set of data and define a specific hypothesis that explains the nature and shape of the set this data may be for example the historical prices for a stock index observations collected from a survey of consumer finances or unemployment and inflation rates in different countries if you are interested in the relationship between the annual price change of the s p 500 and the unemployment rate you d collect both sets of data then you might test the idea that higher unemployment leads to lower stock market prices in this example stock market price would be the dependent variable and the unemployment rate is the independent or explanatory variable the most common relationship is linear meaning that any change in the explanatory variable will have a positive correlation with the dependent variable this relationship could be explored with a simple regression model which amounts to generating a best fit line between the two sets of data and then testing to see how far each data point is on average from that line note that you can have several explanatory variables in your analysis for example changes to gdp and inflation in addition to unemployment in explaining stock market prices when more than one explanatory variable is used it is referred to as multiple linear regression this is the most commonly used tool in econometrics some economists including john maynard keynes have criticized econometricians for their over reliance on statistical correlations in lieu of economic thinking there are several different regression models that are optimized depending on the nature of the data being analyzed and the type of question being asked the most common example is the ordinary least squares ols regression which can be conducted on several types of cross sectional or time series data if you re interested in a binary yes no outcome for instance how likely you are to be fired from a job based on your productivity you might use a logistic regression or a probit model today econometricians have hundreds of models at their disposal econometrics is now conducted using statistical analysis software packages designed for these purposes such as stata spss or r these software packages can also easily test for statistical significance to determine the likelihood that correlations might arise by chance r squared t tests p values and null hypothesis testing are all methods used by econometricians to evaluate the validity of their model results limitations of econometricseconometrics is sometimes criticized for relying too heavily on the interpretation of raw data without linking it to established economic theory or looking for causal mechanisms it is crucial that the findings revealed in the data are able to be adequately explained by a theory even if that means developing your own theory of the underlying processes regression analysis also does not prove causation and just because two data sets show an association it may be spurious for example drowning deaths in swimming pools increase with gdp does a growing economy cause people to drown this is unlikely but perhaps more people buy pools when the economy is booming econometrics is largely concerned with correlation analysis and it is important to remember that correlation does not equal causation 