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1.2 Causal Effects and Idealized Experiments 51

by using the past, and econometricians do this by using economic theory and
statistical techniques to quantify relationships in historical data.

The data we use to forecast the growth rate of GDP are past values of GDP
and the “term spread” in the United States. The term spread is the difference
between long-term and short-term interest rates. It measures, among other things,
whether investors expect short-term interest rates to rise or fall in the future. The
term spread is usually positive, but it tends to fall sharply before the onset of a
recession. One of the GDP growth rate forecasts we develop and evaluate in
Chapter 14 is based on the term spread.

Quantitative Questions, Quantitative Answers

Each of these four questions requires a numerical answer. Economic theory pro-
vides clues about that answer—for example, cigarette consumption ought to go
down when the price goes up—but the actual value of the number must be learned
empirically, that is, by analyzing data. Because we use data to answer quantitative
questions, our answers always have some uncertainty: A different set of data
would produce a different numerical answer. Therefore, the conceptual frame-
work for the analysis needs to provide both a numerical answer to the question
and a measure of how precise the answer is.

The conceptual framework used in this book is the multiple regression model,
the mainstay of econometrics. This model, introduced in Part II, provides a math-
ematical way to quantify how a change in one variable affects another variable,
holding other things constant. For example, what effect does a change in class size
have on test scores, holding constant or controlling for student characteristics (such
as family income) that a school district administrator cannot control? What effect
does your race have on your chances of having a mortgage application granted,
holding constant other factors such as your ability to repay the loan? What effect
does a 1% increase in the price of cigarettes have on cigarette consumption, hold-
ing constant the income of smokers and potential smokers? The multiple regres-
sion model and its extensions provide a framework for answering these questions
using data and for quantifying the uncertainty associated with those answers.

1.2 Causal Effects and Idealized Experiments

Like many other questions encountered in econometrics, the first three questions
in Section 1.1 concern causal relationships among variables. In common usage, an
action is said to cause an outcome if the outcome is the direct result, or consequence,