A Formal Analysis of the Cambridge Economic Policy Group Model

Abstract

Two propositio,ns about management of the British economy advanced by the Cambridge Economic Policy Group (CEPG) have aroused some controversy. One concerns the relationship between fiscal policy and the balance of payments; the other concerns the relative merits of import restricts and devaluation as alternative means of achieving full employment. Both have also caused confusion and misunderstanding because they were not formulated with sufficient precision when originally advanced in newspaper articles (especially Godley and Cripps, 1974) and annual policy reviews (CEPG, 1975, 1976). The policy reviews were based on a fully defined computer model (the current version is described in Fetherston, 1976), but because this was developed for realistic quantitative analysis it is too complicated and too specific to be suitable for a general exposition. This paper provides a simplified presentation of the main assumptions of the CEPG model and derives from them some precise conclusions about the effects of fiscal and trade policy. Little or no attempt is made to justify the assumptionls, the purpose being to clarify what has been asserted rather than to argue in favour of these conclusions against others. The quantitative model used for policy reviews was always intended to evolve in the light of experience and criticism and in response to the changing focus of interest in specific policy objectives and instruments. The assumptions and conclusions presented here are still provisional. In order to derive the theorems in an intelligible analytic form, some simplifications to the realistic quantitative model have been adopted. In particular, disaggregation of components of the current balance of payments, output, national income and public accounts, as well as short-run dynamics, have all largely been omitted. The first section of the paper gives an overall, verbal description of the model to indicate how it relatcs to diitTerent theoretical traditions. The three following sections describe in turn .ISSulmptions relating to real demand, external trade and inflation, and derive specific propositions about relationships between targets and instruments. The final section outlines properties of the model as a whole, based on results from the preceding sections.