An Introduction to MDM-E3: Purpose and Design

Background and history

The Cambridge Multisectoral Dynamic Model of the UK economy (MDM-E3) is the UK's most detailed integrated energy-environment-economy (E3) model, designed to analyse and forecast changes in economic structure, energy demand and resulting environmental emissions. The current version of MDM-E3 is based on the 2003 Standard Industrial Classification (SIC03). The model has a pedigree that goes back to the combined static input-output and linear-expenditure system of the Cambridge Growth Project (Stone and Brown, 1962 and 1965), one of the first large-scale econometric models to be solved on a mainframe computer (Refro, 2003). The model became dynamic in the late 1970s (Barker, 1975). A comprehensive account of an earlier version of the economic model is given in Barker and Peterson (1987).

This manual gives most detail to the way in which MDM-E3 determines economic output, prices, employment, energy demand, and environmental emissions.

The treatment of the economy in MDM-E3

The purpose of MDM-E3 is to abstract the underlying patterns of behaviour from the detail of economic life in the UK and represent them in the form of a key set of identities and equations. In a complex system, such as the UK economic system, the abstraction is very great. In any economic model the initiatives, responses and behaviour of millions of individuals is aggregated over geographical areas, institutions, periods of time and millions of heterogeneous goods and services into just a few thousand statistics of varying reliability. The aim of MDM-E3, then, is to best explain movements in the data and to predict future movements under given sets of assumptions.

A key contribution of the approach to modelling the UK economy in MDM-E3 is the level of disaggregation. The macroeconomic aggregates for GDP, consumers' expenditures, fixed investment, exports, imports, etc are disaggregated as far as possible without compromising the available data.

One reason for disaggregation is simply that it is necessary to answer certain questions of economic interest. Some macroeconomic questions are intrinsically structural and if they are to be answered using a model then it must be disaggregated in some way. The disaggregation of agents and products is crucial in trying to understanding the behavioural responses of heterogeneous agents as it reduces the bias encountered in estimating aggregate relationships.