On Logical Validity and Econometric Modeling : the Case of Money Supply

The three pillars of econometric modeling are: (1) the reduced form, (2) the recursive form, and (3) the structural form. Each of these techniques exists for the purpose of revealing the joint conditional probability distributions of current and lagged endogenous variables conditional on the values of exogenous variables. The purpose of this paper is to discuss a weakness in econometric approaches that may involve logical inconsistencies in conditioning assumptions. To circumvent this logical dilemma, an alternative methodology is proposed and illustrayed using a money supply equation originally due to K. Brunner and A. Meltzer