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O F P H IL A D E L P H IA
Economic Man vs. Social Man
The Geography of Crime
A Noneconomist’s
Nonmathematical Guide to
Econometric Forecasting
F E D E R A L

R E S E R V E

B-A-ISTK

F E D E R A L

R E S E R V E

B A N K

BUSINESS REVIEW

is produced in the Departm ent of Research. Ron ald B. W illia m s is A rt Director. The auth ors will
be gla d to receive c o m m e n ts on their articles.
R e qu e sts for additional co pies sh o u ld be ad dressed to Public Services, Federal Reserve B a n k of Philadelphia, Philadelphia,
Penn sylvan ia 19101.

E c o n o m ic M a n

O CTO BER 1970
B U S IN E S S REVIEW

by David P. Eastburn, President,
Federal Reserve Bank
of Philadelphia

S o c ia l M a n

P r o d u c t io n .................. ............ Distribution
Quantity ...................... .................. Quality
G oods and services . . . . ..................People
M oney v a l u e s .............. ......... H um an values
W ork and d is c ip lin e ....... ....... Self-realization
...........Cooperation
Com petition ..............
Laissez-faire .............. ...........Involvem ent
Inflation ...................... ....... Unem ploym ent

Economic Man tends to be concerned pri
marily with producing goods and services, with
quantitative problems. He is largely responsible
for the doubling in the nation’s real output over
the past quarter of a century. Ironically, how
ever, his very success has made it possible for
Social Man to gain a sympathetic hearing for his

* ©1970 by The New York Times Company.
Reprinted by permission.

FEDERAL RESERVE B A N K OF PHILADELPH IA

Economic Man
vs. Social Man*

With attention focused on violence in the
Parrot’s Beak, Kent State, and countless city
streets, there is danger of losing sight of a
desperate conflict underlying much of the vio
lence. This is the conflict between Economic
Man and Social Man.
Each of us, of course, is both Economic and
Social Man. Each of us is concerned with making
a living and with living with his fellows, but the
mix varies, and it is there that the source of
conflict lies. Those who are 90 per cent Eco
nomic Man see today’s world differently from
those who are 90 per cent Social Man. Many, in
whom the proportions more nearly approach
50-50, are torn apart by conflicting beliefs. And
so we have a kind of national schizophrenia
which is both divisive and debilitating.
It is easy, of course, to overdraw the con
trast between economic and social values, but
as a first approximation, let us consider the fol
lowing shorthand description of characteristics
and concerns:

concerns about the distribution of output and the
quality of life. The turning point for many was
the appearance of J. K. Galbraith’s The Afflu
ent Society in the late 1950’s. Galbraith made a
persuasive argument that the problem of produc
tion in this nation has been solved. It is no coin
cidence that the war on poverty followed in the
1960’s and concern for the environment prom
ises to be the issue of the 1970’s.
Economic Man embodies many of the values
of the Establishment which youth today finds
so distasteful. He believes that a relatively free
pursuit of self-interest has served this nation
well; that self-interest in a market economy is
expressed largely in monetary terms; that mone
tary rewards are directed by competition to the
efficient and enterprising; and that the Puritan
Ethic of hard work and self-discipline is still a
major guidepost to the good life.
Social Man sees the good life reached by a
quite different route. He stresses people rather
than things; human rather than monetary
values; and freedom not to pursue one’s selfinterest but to realize one’s true individuality by
involvement in a cooperative way in solving
society’s problems.
Obviously, these are caricatures, not carefully
toned portraits, yet it is precisely because such
black-and-white conceptions exist that much of
the current conflict is possible.
Consider, for example, the present effort of
the Federal Government to steer a narrow
course between inflation and recession. This task
is made particularly difficult because of the clash
of economic and social values.
In the 1920’s the problem was simpler. When
inflation got out of hand, the orthodox solution
was to clamp down on the economy. In the
ensuing recession, men were unemployed, but
prices came down. Recession was believed to

be not only inevitable but a necessary purgative;
it was the bitter medicine we had to take for
living it up.
The Great Depression changed this view. It
brought home the tremendous costs of idleness,
the psychological maiming of a whole genera
tion. Consequently the nation resolved in the
Employment Act of 1946 to prevent a recur
rence of such disaster. The idea of the inevita
bility of milder recessions persisted during the
1950’s, however.
In the 1960’s the public began to hope that
recessions might be avoided altogether, and as
the decade proceeded, this hope was increasingly
bolstered by unprecedented success in keeping
the economy growing. It was about at this time
also that the nation became increasingly con
scious that everything was not well socially.
And as prices rose at a quickening pace in the
latter 60’s, public authorities became confronted
with a dilemma more perplexing than ever
before: how to curb inflation without incurring
recession. The dilemma is now in its acute
phase.
Economic Man is on one side. He has been
telling the authorities: hang on; don’t let up on
efforts to curb inflation until you really have it
licked; if this means recession, better pay the
price now than a bigger one later.
Social Man is on the other side. He fears that
a recession will hurt most those who are already
disadvantaged. When unemployment rises, as it
must when the economy slows, those who are
laid off first are the unskilled; efforts to recruit
workers from the ghetto are suspended. Social
Man, therefore, is inclined to trade inflation for
jobs.
It is not exactly clear why these positions are
held as firmly as they are. There are economic
and social costs in both inflation and recession.

. . . The poverty of the incapable, the distresses
that come upon the imprudent, the starvation
of the idle, and those shoulderings aside of the
weak by the strong, which leave so many “ in
shallows and in miseries,” are the decrees of a
large, far-seeing benevolence.

OCTOBER 1970
B U S IN E S S REVIEW

Social action taken in the 1930’s and since has
brought us a great distance.
Tacked on to the end of this long-run trend
has been a new awareness on the part of cor
porations in the past decade of their social
responsibilities. Motivations behind this latest
development are varied, but for the most part
are perfectly consistent with the traditional
forces of self-interest that drive Economic Man.
Looking to the longer run, businessmen see
growing markets among Negroes, a supply of
manpower from the ghetto, and good will from
efforts to improve the environment.
All this has become the conventional wisdom
as far as Economic Man is concerned. He may
be less aware, however, of an equally valuable
benefit from social action: it can enhance the
possibility that public authorities might achieve
a stable economy. Unemployment compensation
and minimum income maintenance provide buf
fers between the disadvantaged and recession.
Better training and education make it possible for
those who are presently disadvantaged to hold
their own in recession. If public authorities
could gain more assurance that their actions will
not bear down unfairly on the poor and greater
confidence that their economic policies will not
have severe social side effects, they could move
with more vigor and effectiveness against infla
tion whenever it threatened. Social action, in
short, promises Economic Man not only expand
ing markets in which to sell his wares but a
more stable economy in which to produce them.
Economic Man need not become a bleedingheart liberal to espouse social programs to im
prove the lot of the disadvantaged. They are in
his own self-interest.
At the same time, Social Man needs to under
stand what to Economic Man is a central con
cept of life: opportunity costs. This is the

FEDERAL RESERVE B A N K OF PHILADELPHIA

Both ultimately can destroy our economy. Both
cause severe distress to important groups in
society (10 per cent of the population, for exam
ple, is over 65, many on fixed incomes that are
eaten up by inflation; 7.6 per cent are working
poor, many of whom are put out of work in
recessions). The fact is, however, that Eco
nomic Man tends to be concerned primarily
about inflation and Social Man about recession,
and so an issue of great significance to the entire
nation has tended to become polarized.
It is a truism to say that the only reliable
road to lasting domestic peace is through under
standing. It may well be, however, that contro
versy between races and generations contains
such a large component of emotion that a frontal
attack will only produce more discord. Better
understanding of underlying economic and social
issues may promise quicker results. A question
of considerable significance, therefore, is what
can Economic Man and Social Man learn from
each other?
Social Man must convince Economic Man that
this nation cannot prosper unless action is taken
to solve social ills. A great deal of progress has
already been made. Indeed, historians may note
some day that one of the most outstanding
achievements of the twentieth century was the
softening of a harsh and inhuman economic phi
losophy, a process which has yielded unprece
dented economic as well as social dividends. It is
impossible, for example, to visualize anyone
today (except possibly Ayn Rand and her dis
ciples ) seriously subscribing to Herbert
Spencer’s philosophy of 1850:

concept that everything has a cost in terms of
opportunities foregone. Resources are scarce and
once a decision is made to use them for one
purpose, they are no longer available for
another. One opportunity cost of reading this
article, for example, is not simultaneously
being able to read one of the others in this
magazine.
Economic Man, by and large, has learned to
live with this principle. He is constantly forced
to use the resources at his command— money,
people, technology— in the best possible way to
get the best possible results. His success in doing
so determines his success as a businessman. He
makes his cost calculations carefully; he sets
priorities. He has developed a degree of patience
and a way of looking toward the long run in
evaluating progress and results. Social Man, by
and large, has yet to get the message. Perhaps
because of his “ human” approach, he tends more
often to look at small parts of the picture, sees
specific problems which could be met with rela
tively small expenditure, and presses for their
solution without realizing the cumulative impli
cations of his proposals. With so many things
needing doing, he is impatient for results. If
Economic Man can— without dulling the edge
of the drive for social betterment— convince
Social Man that everything cannot be achieved
at once, he will have gone a long way toward a
constructive resolution of today’s conflict. Rising
expectations are healthy, but only if we are
aware of the limitations of resources.
Resources are expansible, but in the short
run, attempts to do too much, to solve all our
social problems and still satisfy our inexhaustible

desires for material things, will only produce
inflation. Limited resources force us to make
hard decisions about priorities. The sooner
Social Man learns this economic lesson and
devotes his efforts to winning the public over
to his order of priorities, to giving him a bigger
slice of the pie, the more effective he will be in
solving social problems.
In the longer run, it is possible to meet rising
social needs without sacrificing material com
forts; the slices may be the same, but the pie can
be bigger. Social Man’s best hope is to work
with Economic Man toward the kind of dynamic
economy that will make such a happy solution
possible.
Possibilities of cooperation are greater now
that there is common recognition of a pressing
need to clean up the environment. The environ
ment is something tangible that Economic Man
can understand; and it is free of difficulties
which the Puritan Ethic poses for him in accept
ing such social programs as minimum income
maintenance. At the same time, Social Man can
find in efforts to improve the environment many
opportunities to better the lives of those who
are socially deprived. The danger in the environ
mental issue is that it could divert attention
from the needs of people. The hope is that it
may provide a common ground for Economic
Man and Social Man to come together to work
for their mutual interests.
Both have a vital role to play. Social problems
cannot be solved without a strong and growing
economy, and we cannot prosper economically
if we continue to have large parts of the popula
tion not sharing in the fruits of production.

P H IL A D E L P H IA

Rate Per 1 0 0 ,0 0 0 P op u la tion

AND

THE

OCTOBER 1970

C R IM E :

N A T IO N

R a te Per 1 0 0 ,0 0 0 Pop ula tion

T H E N A TIO N

I
B U S IN E S S REVIEW

The Geography
of Crime*
by Margaret M. Keeney

Source: Federal Bureau of Investigation, CRIME
UNITED STATES, Uniform Crime Reports, 1969.

IN THE

Although reported criminal offenses continued
to climb last year, some regions of the country
were affected more severely than others. The
incidence of reported crime in the Philadelphia
region was considerably below the U.S. average
and the lowest of the ten largest metropolitan
centers in the nation.
* Crime statistics are collected by the U .S. Federal
Bureau of Investigation from local law enforcement
agencies. Although precise guidelines are issued to
individual agencies, discrepancies in reporting pro
cedures may exist because of factors varying from one
community to another. Metropolitan data in this report
refer to Standard Metropolitan Statistical Areas. See
Federal Bureau of Investigation, Crime in the United
States, Uniform Crime Reports, 1969.

FEDERAL RESERVE B A N K OF PHILADELPHIA

The majority of all criminal offenses were
crimes against property (burglary, larceny of
$50 or more, and auto theft). In 1969, when
crime increases hit every major city, Philadel
phia maintained a relatively favorable position
by recording the lowest rate of property
offenses.
PROPERTY

Rate Per 1 0 0 , 0 0 0 Pop ula tion

V IO L E N T

Rate Per 1 0 0 ,0 0 0 P op u la tion

C R IM E S

R a te P e r 1 0 0 ,0 0 0 Pop ula tion

----

T H E N A T IO N

O FFEN SES

R a te P e r 1 0 0 ,0 0 0 P op u la tion

Source: Federal Bureau of Investigation, CRIME
UNITED STATES, Uniform Crime Reports, 1969.

IN THE

Metropolitan areas experiencing the highest
incidence of crime against property also
recorded the highest rates of violent crimes
( murder, forcible rape, robbery, and aggravated
assault). Although violent crime increased in
all major metropolitan areas in 1969, the rate
of violence in the Delaware Valley remained
below the national average.

IN THE

The crime rate in Philadelphia has been below
the U.S. average over the past decade. The gap
between local and national experience began to
widen in 1966 when property crime in Phila
delphia was substantially below the national
average and the region’s rate of violent crime
actually declined.

O CTOBER 1970

A D E C A D E O F C R IM E
Rate Per 100,000 Population

T H E G R O W T H O F V IO L E N T C R IM E
IN T H E 1 9 6 0 ’S

B U S IN E S S R EV IEW

Rate Per 100,000 Population

Source: Federal Bureau of Investigation, C R IM E IN THE UNITED STATES, Uniform Crime
Reports, 1960 to 1969.

T H E G R O W T H O F P R O P E R T Y C R IM E
IN

THE

1 9 6 0 'S

Source: Federal Bureau of Investigation, C R IM E IN THE UNITED STATES, Uniform Crime
Reports, 1960 to 1969.

Despite Philadelphia’s relatively good stand
ing among other urban centers, the increase in
the absolute level of crime in each of the past
ten years results in staggering economic and
social costs for the Delaware Valley.

Source: Federal Bureau of Investigation, C R IM E IN THE UNITED STATES, Uniform Crime
Reports, 1960 to 1969.

FEDERAL RESERVE B A N K OF PHILADELPHIA

Rate Per 100,000 Population

A Noneconomist's
Nonmathematical
Guide to Econometric
Forecasting
by Ira Kaminow

In 1938 the famous magazine, Literary Digest,
went out of business after (and many people
believe because) its primitive public opinion
poll failed to predict F.D .R.’s victory in the
1936 election. It is fortunate that Harvard
University did not suffer a similar fate when
its primitive econometric forecasting model
( The Harvard Business Barometer) failed
to predict the Great Crash of 1929. While the
school was saved, the model sunk without a
trace. The Barometer, however, turned out to
be a prototype of all the big, shiny, computerrun econometric forecasting models that were to
follow. These models, like the original Harvard
effort, are highly abstract representations of the
economy or other social systems that use quan
titative techniques and statistical theory to fore
cast social phenomena. It is a measure of the
current esteem for econometric forecasting that
the first Nobel Prize in economics went to Jan
Tinbergen and Ragnar Frisch, who were among
the dozen or so men who laid the foundations
of modern econometric analysis in the 1930’s.
Today, an ever-growing number of coun
tries, rich and poor, capitalist and socialist, use
econometrics to forecast GNP, unemployment,
national labor and resource requirements, and
so on. In the United States alone, dozens of
government agencies, businesses, and univer
sities regularly forecast national economic phe
nomena with econometric techniques. The
techniques are used also by business firms to
forecast costs, sales, and prices; by banks to
forecast deposits and loan demand; by cities to
forecast population shifts and residential pat
terns; by public utilities to forecast service
demand; and by policymakers to forecast the
effects of alternative actions.
Many laymen wonder what econometric fore
casting is all about. Is it a toy or a valuable

No one knows how man first began to speculate
about the future. Somewhere along the way,
however, people began to hit upon the idea of
searching for regularities in the organization of
their environment that could be used to convert
present knowledge into predictions of the
future. What a remarkable event it must have
been when a man first noted that thunder,
clouds, and rheumatism pains were generally
followed by rain.
Down through the ages, the use of regularities
in predicting has become a part of us. We use
them unthinkingly to predict how well we’ll get
along with a new neighbor ( “ I don’t trust peo
ple with shifty eyes.” ); when a spouse will
arrive home ( “ She always gets home late on
Wednesdays.” ); or when the stock market will
recover ( “ The market always rises after the
President makes a speech.” ). We use them more
consciously to predict when the earth and moon
will be aligned well for lunar landing or when
a laboratory animal will push a bar in its cage.
Regularities are used also in nearly all fore
casts of business and social phenomenon. Sales
rise in the Spring; GNP usually falls after a
decline in the money supply; prices go up after
a sales tax is imposed.
WHAT IS ECONOMETRICS?— A PROVISIONAL
ANSWER

Traditionally, social and business predictions

O CTO B ER 1970
B U S IN E S S REVIEW

SPECULATING ABOUT THE FUTURE

have tended to be casual, and regularities have
not been verified systematically. In fact regular
ities are not always explicitly stated or recog
nized by the forecaster. Frequently, forecasters
make rapid forecasts involving many compli
cated relationships. No doubt they use real or
imagined regularities subconsciously in much the
same way that we can all speak at least passable
English without having to consciously make use
of all the rules of grammar. Often when the fore
caster is consciously aware of using regularities,
he states them vaguely. “ If the sales tax goes
up by 10 per cent, prices will rise by 15 or 20
per cent” is as precise a statement as you can
expect from forecasters using traditional tech
niques.
Econometrics is an attempt to make forecast
ing techniques more explicit and quantitatively
precise. This means that suspected regularities
are to be stated as explicitly as possible and sub
ject to systematic tests to see how regular they
have actually been. It also means that the regu
larities are to be stated in quantitative terms.
The relation between prices and sales tax
might be stated by an econometrician: “ On the
average, when the sales tax goes up 10 per cent,
the consumer price index will go up by 17 per
cent. Moreover, there is one chance in three that
it will go up by more than 19 per cent or less
than 15 per cent and two chances in three that
it will increase between 15 and 19 per cent.”
More than merely using explicitness and pre
cision, however, econometrics insists upon them,
and this can lead to trouble. How, for example,
can one explicity set down the tone of the
President’s speech or a prospective customer’s
voice?
A changing world presents another problem.
Econometrics has no way of revealing new regu
larities or changes in old ones until the new

FEDERAL RESERVE B A N K OF PHILADELPH IA

tool? A great breakthrough or the same old
predictions printed on new computer paper?
There is, of course, no need for all the mystery.
The basic principles and problems of econo
metrics can be explained or at least illustrated
in a simple fashion.

regime has been operative for some period of
time. Because the technique relies on a systema
tic search for the existence of regularities, it
can operate effectively only after some experi
ence has been accumulated. In contrast, noneconometric forecasters can use intuition,
common sense, or theories to anticipate changes
in regularities.
Against these limitations of the explicit
approach,
econometricians
weigh
several
advantages. First, when an econometrician
writes everything down explicitly, he can see
more clearly the implications of his words. He
will, therefore, less likely say by implication
what he would not have said outright. Second,
by recording each step, he invites debate and
critical comment which permit him to improve
the quality of his forecasts. Finally, by writing
everything down explicitly, the role of each
step in the final forecast becomes more appar
ent. This allows the forecaster to see how
things would have been different if this or that
factor were changed.
As it turns out, we need not make a hard
choice between the econometric and traditional
methods. Econometric techniques can be used
for some problems, while we save the more
traditional techniques for other problems, or
we can use both techniques in tandem. Some
policymakers use more than one forecast and
then try to reconcile any conflicts among them
to arrive at a final forecast.
THE SEARCH FOR REGULARITIES

The search for regularities takes place in the
data of the past. Economic or other theory, intu
ition, and knowledge of social institutions sug
gest the factors that are likely to be good
indicators of the phenomenon that is to be pre
dicted. But only by putting on his work clothes
and going into the mines of past data can the

econometrician find out which variables tradi
tionally have been the best indicators. He knows,
of course, that there is no guarantee that past
regularities will continue to hold in the future.
This only means that he must be careful lest he
come out of the mines with fool’s gold. The
econometrician recognizes, however, that past
experience is the only experience he has, so there
is really nowhere else to look.
ESTIMATING INFLUENCES

Mining the data is a two step process. Both
steps are usually carried out simultaneously, but
we shall look at them as though they were taken
sequentially. The first step is to estimate the
past relation between each candidate indicator
and the phenomenon we will forecast.
Suppose an econometrician wants to forecast
sales of Super Eight Boodle Buggies. The indi
cators he will look at will no doubt include
price; some measure of the level of prosperity,
such as GNP; the availability of credit; and so
on. To make the game simple, we will assume
that he is concerned only with the relation
between price and sales. To make the game
interesting, we shall watch the econometrician
from Mount Olympus where the true relation is
known: if nothing else changes, a fifty dollar
change in price will lead to a change in sales
of 500 buggies.
The econometrician, of course, does not know
this. All he can observe is a list of prices and
the volume of sales associated with each price.
Since factors other than price will influence
sales, the true relation between the two will
be obscured. On one occasion, sales may have
changed (because of factors other than price)
with no changes in price. On another, a fifty dol
lar cut in price might have been followed by an
increase in sales of 700 cars, while at some other

response midway between the highest and lowest
observed responses. Actually, the econometrician
will use neither of these estimating rules, but he
will use an arithmetic rule that is no more com
plicated than the two suggested here. A more
detailed discussion of the rules econometricians
use can be found in the accompanying box.

O CTO BER 1970

time a one-hundred dollar price boost choked off
sales by only 100 cars. How does the econome
trician use the somewhat haphazard observed
relation between price and sales to estimate the
true response of sales to price changes? One pos
sibility would be to use an average of all ob
served responses. Another might be to use the

FEDERAL RESERVE B A N K OF PHILADELPH IA

estimates of the same underlying number.) A
technique that gives estimates which tend to average
out around the true value is called unbiased; a
technique that is relatively insensitive to the partic
ular sample chosen is efficient. Obviously, the most
desired estimating techniques are the least biased
and most efficient.
Clearly, econometricians cannot observe a large
number of successive sets of data. There is no way
they can select a large number of twenty-year peri
ods, say, that are identical with respect to the price
of Boodle Buggies. At first blush, it would seem
that bias and efficiency are not really relevant to
econometric problems. This, however, is not so.
There is no reason for us to be restricted by physi
cal constraints if our minds can exceed them. Econo
metricians have devised techniques that would yield
estimates with the desirable properties if it were
possible to obtain a sufficiently large number of
estimates. Indeed, it is the very substance of econo
metric theory to tell us the circumstances under
which the desirable properties are available. For
example, when some rule is biased or when one rule
has the same bias but is more efficient than another.
For forecasting purposes, the prediction is prob
ably the most important characteristic to be cal
culated, but its usefulness is considerably increased
if the user knows the standard error of the estimate,
which is a measure of the extent to which pre
dictions tend to deviate from the actual values.
If observed values tend to be near their estimated
expected values, the standard error of the estimate
will be low.

B U S IN E S S REVIEW

MORE ABOUT ECONOMETRIC ESTIMATING TECHNIQUES
Rather than just select an estimating technique at
random, econometricians usually establish properties
which they consider desirable and then choose a rule
which combines these properties in some satisfactory
way.
Econometricians recognize that any estimate is
due in part to chance, because it depends in part on
the particular values that were observed. In terms
of the Boodle Buggie problem, the econometrician
observed a limited number of combinations of
prices and sales. Sales were influenced in part by
the price, but also in part by other factors. Had he
observed another period with exactly the same
prices, sales would have been different. With the
same set of prices, but different sales figures, the
econometrician’s estimate of the influence of price
on sales would naturally be different.
If we viewed the world through the econometri
cian’s eyes, we would act as though it were con
ceptually if not actually possible to observe a large
number of periods that were identical with respect
to Boodle Buggy prices but differed in all other
respects. Each time we would get a different set of
sales and a different estimate of the influence of
price on sales. In evaluating alternative estimating
techniques, econometricians are concerned with the
distribution of these various estimates.
The two properties that econometricians most
frequently look at are: (1) the average or expected
value of the estimates; and (2) the sensitivity of the
estimates to the particular sample chosen. (An esti
mation rule which was very sensitive to the particu
lar sample observed would produce widely differing

THE CUT

Having estimated the quantitative impact of
each candidate indicator, the next step is to cut
out all those that have not shown evidence of
helping to anticipate the movements in Boodle
Buggy sales, or whatever it is the econometrician
wants to forecast. To test each potential indi
cator from this point of view, the econometrician
simply makes sample predictions with and with
out each indicator to see how much each one
helps.
First, he uses his estimates to find out what
his forecast would have been in each past year.
For example, in 1959, the price was $2,500;
GNP was $484 billion; etc. Based on the esti
mates of the influence of each of these factors,
sales should have been 80,000 units. The next
step is to find out what his predictions would
have been without the indicator that is on the
line by simply ignoring its influence. If, on the
average, these predictions are significantly better
with the indicator than without, the indicator
stays; if not, it gets cut. There are, of course,
objective measures of whether the indicator adds
significantly to the predictions.
WHY ECONOMETRICIANS DISAGREE

The claim of econometrics is merely that the
practitioner is explicit and quantitative. It is
objective in no other sense. It eliminates neither
error nor controversy. All claims to the contrary
by both supporters and opponents are demon
strably false.
The most frequent challenge faced by the
econometrician is that he has neglected some
crucial point that makes the past regularities
he has uncovered irrelevant or potentially irrele
vant for the future. There is limitless opportu
nity for econometricians to overlook important

considerations and, so, limitless opportunity
for disagreement and error. It would be impossi
ble for us to look at all the fields on which
econometricians do battle. However, a brief
glimpse at a few might serve to illustrate the
kinds of pitfalls that face the unwary.
Finding the Form. One trap whose jaws await

the econometrician concerns the form of the
relation between two variables. In the Boodle
Buggy problem, we let the econometrician know
from the outset that the response of the number
of cars sold to any given change in price was
constant. Because he knew this, he had a leg up
on the problem— all he had to do was to esti
mate the constant response. Usually, the econo
metrician does not know the form of the
relation, however, so he must take a shot in the
dark. For example, he might guess that the
percentage response of Boodle Buggy sales to
any given percentage change in price is con
stant. Now, whatever estimating rule he uses
will give him some estimate of this supposed
constant percentage response of sales to price.
Obviously, however, since the econometrician
estimated the wrong thing, his estimate cannot
possibly be correct. The dangers of an incorrect
specification of the form will depend, of course,
on how close the imposed form is to the “ true”
form. A particularly sinister problem arises
when the degree of similarity of the two forms
changes over time, for then past regularities
become inapplicable to the future.
The Problem with Leaving Things Out. In look
ing at the influence of each indicator, the econo
metrician must not ignore the possible influence
of other factors. Otherwise, in his singleminded
ness, he might attribute the influence of one
factor to another.

battleground that should not be left out of our
discussion. If an econometrician wants to pre
dict, he must use as indicators variables that are
known at the time the predictions are made. In
the jargon of econometrics, these are known as
the predetermined variables. Now sometimes a
regularity is uncovered that does not involve
any predetermined variables. Imagine, for ex
ample, that consumption in any year is related to
income in that year. Clearly, this relationship by
itself cannot be useful in predicting consump
tion, because by the time we know income, we
also know what consumption was. However, if
national income can be shown to depend on
some predetermined variable, such as govern
ment expenditures, we can use the two relations
to predict consumption.
One way would be to: (1 ) estimate the rela
tionship between government expenditures and
income; (2 ) use this relation to estimate income
using known figures on government expendi
tures; and (3 ) plug the income figure into an
estimated relationship between income and con
sumption. The estimates of the relations so
obtained are called the structural estimates, be
cause they are concerned with the system’s
underlying structure. If we are not interested
in the structure, we can squeeze the system into
what is known as its reduced form simply by
estimating the net relation between govern
ment expenditures and consumption directly.
Implicit in this relationship will, of course, be
the two structural relations.
Now, the choice between estimating reduced
forms and structures is among the most inter-

O CTO BER 1970

Structure vs. Reduced Form. There is one last

B U S IN E S S REVIEW

such a case, the econometrician will have no way
of knowing that both help to determine the
phenomenon he is trying to predict.

FEDERAL RESERVE B A N K OF PHILADELPH IA

We can illustrate this point by going back to
the Boodle Buggy problem. Suppose that adver
tising expenditures influence sales but have not
been acknowledged explicitly by the econometri
cian. If the Boodle Buggy Company usually
alters advertising expenditures to partially offset
price changes, the econometrician must allow the
estimating technique to recognize the link be
tween advertising expenditures and price. If he
does not, the estimate of the influence of price
on sales will be too low. Whenever price
changes, it will appear to have a smaller influ
ence than it actually does, because increased
advertising expenditures will tend to offset the
price effect. The econometrician’s estimate of the
influence of price on sales will almost surely be
biased downward.
As long as the relation between price and
advertising expenditures persists, the quality of
predictions will be unimpaired, because changes
in price will adequately capture movements in
advertising expenditure. It would be a sorry
executive who took the estimate of the weak
response too literally, however. For then, like
the man who wanted to move the sun to the
evening because it was already light enough in
the day time, he might decide that there is no
need to squander all that money on advertising.
The illustration we used here might seem
obvious, but an econometrician can never be
sure that he has included all important indica
tors. Indeed, the very similarity in the move
ments of two variables may cause the econome
trician to neglect one of them as an indicator,
even though they both exert strong influences
on the phenomenon he is trying to predict.
When two variables move up and down to
gether, the use of both as indicators may be
superfluous, and forecasts using both may not
be much better than those using only one. In

esting in econometrics. The structure clearly
provides the most information and detail. To
know the structure is to know not only the rela
tion between the predetermined variables and
the phenomenon to be predicted, but also the
“ intermediate” steps that connect the two.
Among the advantages that can be claimed for
this information is the fact that the results of
any changes in the intermediate relations can
easily be incorporated into the estimates.
Another advantage provided by estimates of
the intermediate relations is the opportunity to
check these estimates for consistency with any
related evidence that has been gathered in other
contexts, as well as our own beliefs about what
is “ reasonable.” A reduced form merely indi
cates the net relationship and suppresses the
underlying relations by which the “ reasonable
ness” of the regularity can be judged. To argue
that government expenditures influence con
sumption without reference to, or testing of, the
logical links between the two— government
spending’s influence on income and income’s
influence on consumption— deprives us of the
opportunity to make statements about why or
how government expenditures should influence
consumption. If a regularity is “ unreasonable”
or if its “ reasonableness” is in doubt, we will
have less confidence in its trustworthiness.
The cost of the additional information and
detail built into the structural approach is an
increased opportunity for error. In our illustra
tion, we allowed government expenditures to
influence consumption only through income.
Suppose that there was, in fact, another channel
through which government expenditures influ
enced consumption. Perhaps consumption is
linked to the interest rates because low interest
rates encourage purchases of durable goods, such
as cars and houses. Because government ex

penditures financed through borrowing changes
interest rates, there will be another channel
through which government expenditures affect
consumption. If we neglect this in the structural
representation, that representation would be
insensitive to a portion of the impluses flowing
from government expenditures to consumption.
The result very well could be distorted forecasts.
Had we used the reduced form procedures,
however, our ignorance would have been quite
unimportant. The reduced form merely postu
lates that government expenditures is a good
indicator of consumption, but it is silent on the
precise nature of the relation between the
two. The econometrician’s reduced form repre
sentation is the same whether there is one or a
hundred channels, and the discovery of new
channels will not cause him to change it.
A QUICK CRITIQUE

Econometrics is a useful forecasting device that
will undoubtedly become more popular and use
ful in the future. Indeed, in many cases, it may
eventually become the major forecasting tool,
and rightly so. But it is easy to overstate the
contribution of econometrics to forecasting. It
leaves most of the major problem of social
and business forecasting unsolved. Recorded ex
perience is very sparse and not always accurate.
This obviously makes the search for regularities
more difficult. Moreover, social phenomenon are
extremely complex and, so, impossible to fore
cast without error. Nothing about current econo
metric techniques can change this. Econometrics
is, as we said in the beginning, a new approach
to what is essentially a very old forecasting
method.
In fact it may be that the greatest contribu
tion of econometrics will be to point out very
clearly and obviously the difficulties inherent in

econometric approach. In the end econometrics
may teach us that we have been fooling ourselves
all along, by overestimating our capacity to fore
see the future by looking to past regularities.

O CTO BER 1970

social and business forecasting. The difficulties
we looked at in the last section are by no means
unique to econometrics. They are, however,
made much more obvious by the rigor of the

PUBLICATIONS LIST
The follow ing publications can be obtained free of charge
through our Public Services Departm ent.

30 pages. Karl R. Bopp, former president
of the Philadelphia Federal Reserve Bank,
describes the purposes and functions of the
Federal Reserve System. Objectives of
monetary policy, instruments of policy, and
organization of the System are high
lighted.
2. A HUMANIST’S VIEW: THE ART OF

MANAGEMENT AND OTHER TALKS
46 pages. A collection of six speeches by
Robert N. Hilkert, former first vice presi
dent of the Philadelphia Federal Reserve
Bank. Titles are: “ The Art of Manage
ment;” “ Why People W ork;” “ Training—
For Boredom or Excitement?;” “ The Re
sponsibility of Business and Industry for
Social Welfare in Today’s W orld;” “ Volun
tarism and Social Responsibility in the
United States;” “ Business . . . As it Looks
to a Man of Religion.”
3. THE MYTH OF FISCAL POLICY:

THE MONETARIST VIEW
11 pages. Reprinted from December,
1969 business Review. Examines the cur

rent debate over the efficacy of monetary
policy vs. fiscal policy.
4. THE FOUR HATS OF THE

FEDERAL RESERVE
11 pages. A pamphlet that describes the
four main jobs done by the Nation’s cen
tral bank.
5. MONETARY POLICY:

DECISION-MAKING, TOOLS, AND
OBJECTIVES
52 pages. A collection of articles dealing
with such topics as the relation between
government and the central bank, how
policy decisions are made, guides to mone
tary policy, administration of open market
operations and the discount window, and
the problem of conflicting objectives. (For
bankers, economists, businessmen, teachers,
or other students of money and credit.)
April, 1961.

6. THE QUEST FOR STABILITY
54 pages. Five essays describing efforts to
achieve an efficient monetary system in
the United States. The first two essays give
a historical review of U.S. monetary devel
opments, the third explains the major

FEDERAL RESERVE B A N K OF PHILADELPH IA

1. INTRODUCTION TO THE FEDERAL
RESERVE SYSTEM

B U S IN E S S REVIEW

FEDERAL RESERVE BANK OF
PHILADELPHIA

tools of Federal Reserve policy, the fourth
describes the role of fiscal and debt man
agement policies, and the last discusses the
limitations and interrelations of monetary
and fiscal policy. (For bankers, business
men, teachers, or other students of money
and credit.) Revised 1954.
7. DEFENDING THE DOLLAR
44 pages. A persistent deficit in our bal
ance of international payments has resulted
in substantial drains on our gold reserve.
This problem is discussed in the pamphlet.
8 . MONETARY POLICY: IS THE

MONEY SUPPLY ALL THAT
MATTERS?
Reprint from January, 1966 business Re
view— article by C. J. Anderson. A suc
cinct summary of the current status of
monetary theory.
9. SERIES FOR ECONOMIC

EDUCATION
A series of pamphlets that will attempt to
describe our business system as it actually
operates. The booklets are dedicated to the
idea that if what is taught is different from
what actually takes place, then there is
danger of ending up with text-book eco
nomics quite separate and apart from the
living thing. (Useful to business, schools,
unions, trade associations, banks, and other
organizations.) Titles to date: “ The Price

Digitized for 18
FRASER

System;” “ Unemployment in prosperity—
W hy?;” “ The Mystery of Economic
Growth;” “ G old;” “ Automation;” “ The
New Poverty;” “ The Balance of Pay
ments;” “ The National D ebt;” “ Inflation
and/or Unemployment;” and “ Truth in
Lending/What It Means for Consumer
Credit.”
10. MAINSPRINGS OF GROWTH
109 pages. A collection of articles on the
structure and future of the Philadelphia
metropolitan area. March, 1967.

11. 50 YEARS OF THE FEDERAL
RESERVE ACT
20 pages. A chronicle of the major
changes in the Federal Reserve Act in the
50-year span, 1913-1963. Special emphasis
is placed on tracing the evolution of the
role of the Federal Reserve System along
with the changing economic environment.
A handy synopsis of changes in the struc
ture and powers of the System is included.
(For bankers, businessmen, economists,
teachers, and students of money and
credit.) 1964.
12. GUIDE TO INTERPRETING

FEDERAL RESERVE REPORTS
40 pages. Explains how Federal Reserve
Banking reports are used to analyze finan
cial and economic developments. (For busi
nessmen, bankers, teachers, and students
of money and credit.)

Federal Reserve Bank of Philadelphia
Public Services Department
925 Chestnut Street
Philadelphia, Pennsylvania 19101

Please indicate those publications you wish by plac
ing quantity in box corresponding to number of
publication.

NAM E
ADDRESS
CITY

___

STATE

Z IP

FOR THE RECORD

2 YEARS
AGO

YEAR
AGO

AUG.
1970

Third Federal
Reserve District
Per cent change
SU M M ARY

August 1970
from
mo.
ago

year
ago

8
mos.
1970
from
year
ago

2 YEARS

YEAR
AGO

Manufacturing

United States

from
mo.
ago

year
ago

8
mos.
1970
from
year
ago

+ 3
0
+ 1
0
+ 2
+26
+48

0
6
4
1

+23
+ 10

+ 2
- 3
+ 2
+ 2
+26
- 2

Total
Deposits* ••

Per cent
change
August 1970
from

mo.
ago

Standard
Metropolitan
Statistical
Areas*

year
ago

mo.
ago

year
ago

mo.
ago

Wilmington ..

year
ago

+ 7

+ 5

+ 17

+ 4

+ 18

Trenton ......
+ 1
+ 37

- 4
+ 3

0
+ 5

+ 6

+ 5

+ 20

+23

Altoona ......

. 0

+ 6

+ 3

+ 10

+ 2

+ 7

+45

+
+
+
+
+
-

2
1
2
2
2
2f

+
+
+
+

6
9
1
6
3
12+

- 1
+ 7
- 7
-1 1
- 3
+ 13 +

+
+
+
+
+
+

2
1
3
3
2
3

+
+
+
+
+
+

6
5
5
1
8
12

0
0

+ 3
+ 6

+
+
+

0
6
3
9
1
11

Harrisburg . ..

+ 11

Johnstown ...

PRICES
Wholesale ................
Consumer ................

Check
Payments**

Atlantic City .

BANKING
(All member banks)
Deposits .................
Loans ....................
Investments ............
U.S. Govt, securities..
Other ...................
Check payments*** ...

Payrolls

LO C A L
CHANG ES

MANUFACTURING
Production ..............
Electric power consumed
Man-hours, total* ...
Employment, total .. . .
Wage income* .........
CONSTRUCTION** ......
COAL PRODUCTION ....

Banking

Employ
ment

Per cent change
August 1970

AUG.
1970

+ 4

-1 0

+ 4

+ 2

+ 11

+ 3

+ 16

+ 3

+ 2

+ 9

+ 2

+ 13

+ 2

+ 7

+ 13

+ 4

+ 6

Lancaster___
Lehigh Valley.
Philadelphia

R ead in g......

Scranton . . . .

+ 3

+ 2

Wilkes-Barre .
ot

•Production workers only
••Value of contracts
•••Adjusted for seasonal variation

+ 6+

+ 4
+ 6

1 15 S M S A 's
^Philadelphia

Y o r k ...........

+ 2

+ 9

+ 10

+ 2

+ 3

•Not restricted to corporate limits of cities but covers areas of one or
more counties.
••All commercial banks. Adjusted for seasonal variation.
•••Member banks only. Last Wednesday of the month.