Economic models consist of two types of equations: Identity relationships and behavioural relationships. Identity relationships are given by accounting identities, such as GDP being equal to the sum of its component parts, and are usually non-controversial. Behavioural relationships, however, are unobservable and are given by model parameters. These parameters may be calibrated (Computable General Equilibrium, CGE models), estimated (econometric models) or imposed by the model user. Typically they vary between countries, between sectors and in the short and long run.
E3ME is an econometric model. Its specification gives the model a strong empirical grounding and means it is not reliant on many of the assumptions common to CGE models. The econometric techniques used to specify the functional form of the equations are the concepts of cointegration and error-correction, allowing short-term dynamic (or transition) outcomes, moving towards a long-term trend. The dynamic specification is important when considering short/medium-term impacts. It is also important for assessing rebound effects, which are included as standard in the model’s results.
E3ME is essentially a dynamic simulation model in which human behaviour is estimated through econometric methods.
The main endogenous variables in E3ME are determined from functions estimated on historical time-series data on socio-economic indicators, energy and material use. There are a relatively small number of model variables for which econometric equations are estimated; around 34 in all. However, these variables may be disaggregated in two dimensions, for example the equations for employment include 43 sectors in each region.
There is a special treatment for the trade equations in E3ME. The approach is similar in nature to a two-tier Armington approach. First, total imports are estimated and then bilateral estimates are made. Export volumes are determined by inverting imports.
The treatment of innovation in E3ME was recently updated in the MONROE research project, to include an enhanced set of technology indices, knowledge spillovers and an improved treatment of human capital. Innovation plays a critical role in many of the scenarios that E3ME is used to assess.