Estimation of Short and Long Run Equilibrium Coefficients in Error Correction Model: An Empirical Evidence from Nepal

Abstract

This study aims to investigate the short and long run equilibrium between the electricity consumption and foreign aid of Nepalese economy during 1974-2012. Unit root test, co-integration test and finally error correction model are the econometric tools to establish the relationship between electricity consumption and foreign aid. In addition to this ordinary least square method is used to find out the foreign aid elasticity and spurious regression. The findings reveal that the variables are non-stationary at their level and they become stationary in their first difference. There are two co-integration equations showing the long run relationship between electricity consumption and foreign aid. There is short and long run equilibrium as indicated by the statistically significant coefficient of foreign aid and error correction term. The long run elasticity coefficient reveals that the 1% change in foreign aid will change the electricity consumption by 0.46%. The results of ECM indicate that there is both short and long run equilibrium in the system. The coefficient of one period lag residual is negative and significant which represent the long run equilibrium. The coefficient is -0.336 meaning that system corrects its previous period disequilibrium at a speed of 33.6% annually to reach at the steady state.