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 (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 Computable General Equilibrium (CGE) models. E3ME combines the features of an annual short and medium-term sectoral model estimated by formal econometric methods with the detail and some of the methods of the CGE models, providing analysis of the movement of the long-term outcomes for key E3 indicators in response to policy changes. It is essentially a dynamic simulation model estimated by econometric methods.
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 and medium-term analysis (e.g. up to 2020) and rebound effects, which are included as standard in the model’s results.
The main endogenous variables in E3ME are determined from functions estimated on historical time-series data on economic indicators, energy and material use. There are a relatively small number of variables for which econometric equations are estimated; around 33 in all. However these variables may be disaggregated in two dimensions, for example in the equations for energy demand there are 22 energy users in each region.
The treatment of innovation in E3ME was recently updated in the MONROE research project, to include an updated set of technology indices, knowledge spillovers and an improved treatment of human capital.