The Purpose and Design of E3ME
The Policy Analysis of Long-Term E3 Interactions
E3ME is intended to meet an expressed need of researchers and policy
makers for a framework for analysing the long-term implications of Energy-Environment-Economy
(E3) policies in Europe, especially those concerning R&D and environmental
taxation and regulation. The model is also capable of addressing annual
short-term and medium-term economic effects as well as, more broadly,
the long-term effects of such policies over the next 20 years, such as
those from the supply side of the labour market.
Most conventional macroeconomic models which are operational in government describe
short and medium-term economic consequences of policies but with a limited treatment
of long-term effects, such as those from the supply side of the labour market,
and this limits their ability to analyse long-term policies. In contrast, Computable
General Equilibrium (CGE) models, have been widely used to analyse long-term
E3 policies. CGE models specify explicit demand and supply relationships and
enforce market clearing, and are therefore seen as desirable characterisations
of long-term outcomes in which markets are assumed to be in equilibrium; for
this reason they have been developed particularly in the US for the analysis
of environmental regulation. However, CGE models are not generally estimated
by time-series econometric methods and they have not typically been subjected
to rigorous historical validation, either in terms of the values of the model’s
parameters or, more broadly, the underlying assumptions with respect to economic
behaviour. They also typically tend to impose the dynamics of the model solution,
and so cannot be used for historical validation of the overall model; the analysis
of short- and medium-term impacts of policy changes, meanwhile, tends to arise
from the assumptions inherent in the model. Their use in forecasting or scenario
projections is therefore more limited. Therefore, CGE models are not necessarily
the most appropriate vehicle for understanding the process of dynamic adjustments
and structural change at the sectoral level.
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 of Europe estimated by econometric methods.
The Method: Long-Term Equations and Short-Term Dynamic
Estimation
The econometric model, in contrast with some macroeconomic models currently in
operation, has a complete specification of the long-term solution in the form
of an estimated equation which has long-term restrictions imposed on its parameters.
Economic theory, for example the recent theories of endogenous growth, informs
the specification of the long-term equations and hence properties of the model;
dynamic equations which embody these long-term properties are estimated by econometric
methods to allow the model to provide forecasts. The method utilises developments
in time-series econometrics, with the specification of dynamic relationships
in terms of error correction models (ECM) which allow dynamic convergence to
a long-term outcome. E3ME is therefore the result of a relatively ambitious modelling
project which expands the methodology of long-term modelling to incorporate developments
both in economic theory and in applied econometrics, while at the same time maintaining
flexibility and ensuring that the model is operational.
The Model and the Research Strategy
E3ME is a detailed model of 42 industrial sectors with the disaggregation
of energy and environment industries, in which the energy-environment-economy
interactions are central. The model is designed to be estimated and solved
for 29 regions of Europe (the EU-27 member states plus Norway
and Switzerland). For the twelve member states that joined the EU in
or after 2004, shrinkage methods are applied to the raw data to estimate
long-term parameters from relatively short data series (1993-2006).
This one-model approach fully integrates energy-environment-economy interactions (and, more recently, material demands) with two-way links between each area. This may be contrasted with the multi-model approach, which was a feature of earlier model-based research in the EU. In practice forging the links between separate modelling tools requires considerable resources and, even if this is overcome (usually through an iterative process), there remains the more basic problem of combining sectoral detail in order to simulate 'bottom-up' policies. E3ME includes these links as standard and therefore provides a robust tool for such analysis. The continuing development of software for linking modelling tools means that, in the future, E3ME may itself be linked to other models, for example in the areas of land use, climate change or transport policy.
Comparative Advantages of E3ME
E3ME has the following advantages over many competing models:
- Model disaggregation
- Econometric pedigree
- E3 linkages
The detailed nature of the model allows the representation of fairly complex scenarios, especially those that are differentiated according to sector and to country. Similarly, the impact, of any policy measure can be represented in a detailed way.
The econometric grounding of the model makes it better able to represent and forecast performance in the short to medium run. It therefore provides information that allows for dynamic responses to changes in policy and that is closer to the time horizon of many policy makers than pure CGE models, which provide long-term equilibrium solutions.
E3ME is a hybrid model. An interaction (two-way feedback) between the economy, energy demand/supply and environmental emissions is an undoubted advantage over models that may either ignore the interaction completely or only assume a one-way causation. For example, the EU ETS includes a cap on CO2 emissions: the model can be used to solve for the CO2 allowance price, allowing for effects on electricity prices and demand, as well as on macroeconomic variables.
Summary of the Characteristics of E3ME
In summary, the characteristics of E3ME are such that the model is:
- elaborated at a European rather than at a national level, with the national economies being treated as regions of Europe
- dealing with energy, the environment, population and the economy in one modelling framework
- designed from the outset to address issues of central importance for economic, energy and environmental policy at the European level
- capable of providing short- and medium-term economic and industrial forecasts for business and government
- based on a system of dynamic equations estimated on annual data and calibrated to recent outcomes and short-term forecasts
- capable of analysing long-term structural change in energy demand and supply and in the economy
- focused on the contribution of research and development, and associated technological innovation, on the dynamics of growth and change.
E3ME: An Energy-Environment-Economy Model of Europe
The stochastic functions of the model
For more information contact
Hector Pollitt
Project Manager - European Modelling
 |
 |