Correlation and Causation in Economics

Dreamstime/TCA

Commentary

Most economists use correlations among the various pieces of unique historical data to empirically estimate the future direction of an economy. For instance, it was observed that the lagged changes in money supply were positively correlated with the growth rate of gross domestic product (GDP). Based on the correlation, some economists mistakenly attempt to assess the prospects for economic growth in terms of GDP via past changes in money supply. According to this line of thinking, it would appear that the lagged money supply growth causes economic growth. We suggest that to establish causality, it is necessary to ascertain the essence of both economic growth and the money supply.

Savings and Economic Growth

To maintain life and well-being, an individual must have at his disposal an adequate amount of goods. These goods, however, are not readily available—they have to be produced. Without tools at his disposal (capital goods), the individual can only secure very few goods directly from nature for his survival. For instance, take an individual stranded in a forest. In order to stay alive, he can only pick up some apples from an apple tree. Apples are the only good available to him that can sustain him.