The Impact of Financial Development on Energy Demand in Transition Economies

Abstract Financial development has proven to be one of the major determinants of energy consumption. Although, the U-curve relationship between financial development and energy demand is frequently featured in the literature, there is not much discussion of nonlinear relationships between financial development and energy consumption. In this study we investigated the nexus of these two phenomena in transitional economy countries over the period from 1990 to 2011 employing a Systems-GMM model and the panel cointegration method. The empirical results reveal strong evidence of an inverse U-shaped pattern for the impacts of financial development on energy consumption. The net total effect of financial development on energy demand implies that a one standard deviation increase in financial depth induces a decrease in energy consumption by 0.09 kg of oil equivalent per capita. We also found evidence of Granger causality of financial development on energy demand. The existence of a linkage between the two has been suggested in an earlier study conducted by Coban and Topcu [26]. Although they established the nonlinear nature of the relationship between financial development and energy consumption, this was only apparent after they divided the sample between older and newer EU members. In this respect the effect of financial development on energy consumption is rather dubious because that study used a dynamic panel data model for 15 countries over the period from 1990 to 2011.