Deciding between alternative approaches in macroeconomics

Journal article

Macroeconomic time-series data are aggregated, inaccurate, non-stationary, collinear and rarely match theoretical concepts. Macroeconomic theories are incomplete, incorrect and changeable: location shifts invalidate the law of iterated expectations and ‘rational expectations’ are then systematically biased. Empirical macro-econometric models are non-constant and mis-specified in numerous ways, so economic policy often has unexpected effects, and macroeconomic forecasts go awry. In place of using just one of the four main methods of deciding between alternative models, theory, empirical evidence, policy relevance and forecasting, we propose nesting ‘theory-driven’ and ‘datadriven’ approaches, where theory-models’ parameter estimates are unaffected by selection despite searching over rival candidate variables, longer lags, functional forms, and breaks. Thus, theory is retained, but not imposed, so can be simultaneously evaluated against a wide range of alternatives, and a better model discovered when the theory is incomplete

Authors: Hendry, DF

• Publication status: Published
• Peer review status: Peer reviewed
• Publisher: Elsevier
• Journal: International Journal of Forecasting
• Volume: 34
• Issue: 1
• Pages: 119–135
• Publication date: 2017-10-18
• Acceptance date: 2017-07-21
• DOI: 10.1016/j.ijforecast.2017.09.003
• ISSN: 0169-2070
• Keywords: model selection; indicator saturation; location shifts; autometrics; theory retention