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What Are the Basis of Econometric Models and Forecasts?

econometric modelsActually, no econometric models are very and truly complete, as all of them contain variables, which the econometric model definition cannot predict because of outside forces beyond the model.  One example is personal income tax because these taxes are the wedge between the net income available to spend and income earned by households.

These taxes are determined by a state as a section or part of the fiscal policy and aren’t explainable by a model. If economists would use such model to forecast an economic activity within a time, say several years, the econometrician should anticipate the future rate of taxes in the information base of the model, and which require assumption if the state will change rates, by how much and when.  More so, econometric modelling would require an assumption about the monetary rules or policy of the central bank, including predictions about a wide range of exogenous variables in forecasting the model’s endogenous variables.

Therefore, an econometrician has to use the latest in economic judgment about the outside factors inherent in econometric modelling and forecasting. Similarly, outside its econometric model definition, a forecast can be wrong due to econometric equations, which are only approximations to the real facts and incorrect assumption about the exogenous variables. These deviations in the equations are model errors.

In most cases then, econometric forecasters think such economic judgment should be used not only in finding out the values of exogenous variables, but it is also in order to minimize the scope of error in a model. In addition, you may find more information about econometrics tutoring by visiting our site.

Image credit: http://www.monash.edu/research/capabilities/leading/economic-modelling.html

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