Theory and Evidence of the New Cambridge Private Expenditure Model

Abstract

The aggregate private expenditure model that was constructed by the New Cambridge (NC) school first proved their hypothesized connection between the current account deficit and the government budget deficit. Then, it was found to produce erratic results. Critics discovered that in addition to specification error with the model, it was very much ad hoc in nature. The estimation technique employed by the NC school was also faulty. This paper argues that the basic hypothesis of the NC model is worth reexamining with new empirical evidence after modifying the model and the estimation technique.