Deciding between alternative approaches in macroeconomics

Working paper

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.

Authors: Hendry, D

• Publication status: Published
• Publisher: University of Oxford
• Series: Department of Economics Discussion Paper Series
• Publication date: 2016-01-27
• Paper number: 778
• Keywords: model selection; location shifts; autometrics; theory retention; indicator saturation