Econometrics Alchemy or Science? Essays in

Since the first edition of this book was published in 1993, David Hendry's work on econometric methodology has become increasingly influential. In this edition he presents a brand new paper which compellingly explains the logic of his general approach to econometric modeling and describes recent major advances in computer-automated modeling, which establish the success of the proposed strategy. Empirical studies of consumers' expenditure and money demands illustrate the methods in action. The breakthrough presented here will make econometric testing much easier.

David F. Hendry is Leverhulme Personal Research Professor of Economics and Fellow of Nuffield College, Oxford. He was previously Professor of Econometrics at both the London School of Economics and the University of California at San Diego.

Preface to the New Edition

xiii

Preface

xv

Acknowledgements

xvii

Introduction

1

(8)

Part I Roots and Route Maps

9

(104)

Econometrics - Alchemy or Science?

11

(18)

Alchemy and Science

11

(1)

Econometrics

12

(2)

Econometrics as Alchemy

14

(6)

Econometrics' Problems

20

(3)

A Structure for Econometrics

23

(4)

Is Econometrics Alchemy or Science?

27

(2)

Stochastic Specification in an Aggregate Demand Model of the United Kingdom

29

(23)

Preamble

29

(3)

Introduction

32

(1)

Methodology: Autocorrelation and Simultaneity

33

(1)

Methodology: Autocorrelation and Dynamics

34

(2)

An Aggregate Demand Model for the United Kingdom, 1957-1967

36

(2)

Methods which Neglect Autocorrelation

38

(1)

Methods Which Treat Autocorrelation but Neglect Simultaneity

39

(5)

A `Limited Information' Treatment of Autocorrelation and Simultaneity

44

(1)

Full Information Estimation of Vector Autocorrelation

44

(4)

Conclusion

48

(4)

Testing Dynamic Specification in Small Simultaneous Systems: an Application to a Model of Building Society Behaviour in the United Kingdom

52

(20)

Preamble

52

(2)

Introduction

54

(1)

Building Societies

55

(10)

The Model of O'Herlihy and Spencer

65

(1)

Statistical Testing of Dynamic Specification in Small Simultaneous Systems

66

(5)

Conclusion

71

(1)

Dynamic Specification

72

(41)

Preamble

72

(2)

Introduction

74

(3)

Data Generation Processes

77

(18)

Finite Distributed Lags

95

(1)

Infinite Distributed Lags

96

(6)

Dynamic Specification in Multi-equation Models

102

(11)

Part II The Development of Empirical Modelling Strategies

113

(174)

On the Time-Series Approach to Econometric Model Building

119

(10)

Preamble

119

(2)

Introduction

121

(1)

Autocorrelation Transforms Applied to Non-stationary Data Series

121

(2)

Differencing Economic Time Series

123

(2)

Simultaneous Equations Systems

125

(1)

Conclusion on Granger and Newbold

126

(1)

On Business Cycle Modelling without Pretending to Have Too Much a priori Economic Theory

126

(3)

Serial Correlation as a Convenient Simplification, not a Nuisance: a Comment on a Study of the Demand for Money by the Bank of England

129

(17)

Preamble

129

(3)

Introduction

132

(1)

COMFAC Analysis

133

(5)

Demand for Money Study of Hacche (1974)

138

(6)

Conclusion and Summary

144

(2)

An Empirical Application and Monte Carlo Analysis of Tests of Dynamic Specification

146

(29)

Preamble

146

(1)

Introduction

147

(1)

Testing Procedures

148

(6)

Empirical Application

154

(5)

Monte Carlo Methods

159

(6)

The Finite Sample Properties of the Tests

165

(7)

Summary and Conclusions

172

(3)

Econometric Modelling of the Aggregate Time-Series Relationship between Consumers' Expenditure and Income in the United Kingdom

175

(35)

Preamble

175

(4)

Introduction

179

(3)

The Data

182

(4)

Three Econometric Studies and their Research Methods

186

(4)

A Standardized Framework

190

(4)

On Multicollinearity

194

(1)

Selection of the `Best' Equation

195

(1)

Measurement Errors

196

(1)

A Simple Dynamic Model

197

(7)

Inflation Effects

204

(4)

Summary and Conclusions

208

(2)

Liquidity and Inflation Effects on Consumers' Expenditure

210

(21)

Preamble

210

(1)

Introduction

211

(2)

Integral Correction Mechanisms

213

(5)

Real Income and Inflation

218

(3)

Empirical Evidence for the United Kingdom

221

(8)

Summary and Conclusions

229

(2)

Interpreting Econometric Evidence: The Behaviour of Consumers' Expenditure in the United Kingdom

231

(15)

Preamble

231

(1)

Introduction

232

(3)

A Reappraisal of DHSY and HUS

235

(4)

The Hall Model

239

(3)

Analysis of Results

242

(2)

`Forward-looking' versus `Backward-looking' Behaviour

244

(2)

Predictive Failure and Econometric Modelling in Macroeconomics: the Transactions Demand for Money

246

(24)

Preamble

246

(2)

Introduction

248

(1)

Predictive Failure and Model Mis-specification

249

(3)

`Simple-to-general' Modelling Methods

252

(4)

From the General to the Specific

256

(4)

Feedback Mechanisms in Differenced Models

260

(5)

Summary and Conclusions

265

(1)

An Empirical Illustration

266

(4)

Monetary Economic Myth and Econometric Reality

270

(17)

Preamble

270

(2)

Present Controvery: a Funeral Pyre or the White Heat of Technical Advance?

272

(2)

Construction and Destruction: Pious Hope versus Hard Reality

274

(2)

Evaluation Criteria: or More Than You Ever Wanted to Know about Testing Models

276

(2)

Empirical Illustration A: or Assertion versus Empirical Evidence

278

(1)

Regime Shifts: or Why Econometrics Textbooks Need to be Rewritten

279

(1)

Empirical Illustration B: UK Money Demand Re-revisited

280

(5)

Empirical Illustration C: US Money Demand Explained

285

(1)

Conclusion

285

(2)

Part III Formalization

287

(130)

The Structure of Simultaneous Equations Estimators

291

(23)

Preamble

291

(2)

Introduction

293

(1)

Simultaneous Equations Estimators

293

(3)

Systems Methods

296

(5)

Individual Equation Methods

301

(5)

Single-equation Methods for Autoregressive Errors

306

(6)

Conclusion

312

(2)

AUTOREG: a Computer Program Library for Dynamic Econometric Models with Autoregressive Errors

314

(16)

Preamble

314

(2)

Econometric Background

316

(4)

Estimator Generation

320

(1)

Numerical Optimization

321

(1)

Method Evaluation

322

(2)

Structure of the Library

324

(2)

The Monte Carlo Programs

326

(1)

Program Validation and Development Stage

327

(1)

Computing Costs

328

(1)

Future Developments

328

(2)

Exogeneity

330

(28)

Preamble

330

(2)

Introduction

332

(2)

Definitions

334

(7)

Examples

341

(6)

Application to Dynamic Simultaneous Equations Models

347

(6)

Summary and Conclusions

353

(5)

On the Formulation of Empirical Models in Dynamic Econometrics

358

(29)

Preamble

358

(4)

Introduction

362

(1)

Theory Models and Empirical Models

363

(2)

An Illustration: the Repayment of Mortgage Principal

365

(3)

An Analysis of Empirical-model Concepts

368

(11)

The Empirical Illustration Reconsidered

379

(3)

Dynamic Simulation

382

(3)

Conclusion

385

(2)

The Econometric Analysis of Economic Time Series

387

(30)

Preamble

387

(1)

Introduction

388

(4)

An Econometric Framework

392

(15)

Estimation

407

(4)

Testing

411

(1)

Model Selection

412

(2)

Conclusion

414

(3)

Part IV Retrospect and Prospect

417

(74)

Econometric Modelling: the `Consumption Function' in Retrospect

419

(25)

Preamble

419

(2)

Introduction

421

(3)

Design Criteria

424

(2)

Data Coherency

426

(3)

Valid Conditioning

429

(2)

Parameter Constancy

431

(3)

Data Admissibility

434

(2)

Theory Consistency

436

(3)

Encompassing

439

(2)

Summary and Conclusion

441

(3)

Postscript: the Econometrics of PC-GIVE

444

(23)

Preamble

444

(1)

An Overview

445

(1)

The Model Class

446

(9)

Model Evaluation

455

(1)

An Information Taxonomy

456

(7)

Test Types

463

(1)

Modelling Strategies

464

(1)

Model Estimation

464

(1)

Conclusion

465

(2)

Epilogue: the Success of General-to-Specific Model Selection

467

(24)

Introduction

467

(1)

Potential Criticisms

468

(8)

Methodological Innovations

476

(3)

Improving the Algorithm

479

(4)

Selection Probabilities

483

(1)

Deletion Probabilities

484

(2)

Improved Inference Procedures

486

(1)

Applying PcGets

487

(2)

Conclusion

489

(2)

References

491

(27)

Bibliography

518

(7)

Index

525

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Econometrics Alchemy or Science? Essays in Econometric Methodology

Summary

Author Biography

Table of Contents

Supplemental Materials