Interpreting Economic Time Series

TLDR: In this article, the authors explore the implications for econometric practice of the principle that people's observed behavior will change when their constraints change and propose a proper definition of people's constraints, which includes among them laws of motion that describe the evolution of the taxes they must pay and the prices of the goods that they buy and sell.

Abstract: This paper explores some of the implications for econometric practice of the principle that people's observed behavior will change when their constraints change. In dynamic contexts, a proper definition of people's constraints includes among them laws of motion that describe the evolution of the taxes they must pay and the prices of the goods that they buy and sell. Changes in agents' perceptions of these laws of motion (or constraints) will in general produce changes in the schedules that describe the choices they make as a function of the information that they possess. Until very recently, received dynamic econometric practice ignored this principle. The practice of dynamic econometrics should be changed so that it is consistent with the principle that people's rules of choice are influenced by their constraints. This is a substantial undertaking and involves major adjustments in the ways that we formulate, estimate, and simulate econometric models.