Financial development and energy consumption in emerging markets: Smooth structural shifts and causal linkages

Abstract

This study examines the dynamic interrelationships among financial development, energy consumption, and economic growth in emerging markets by focusing on accounting for structural changes in causal linkages. We first employ the Toda-Yamamoto causality framework and then augment it with a Fourier approximation which captures structural shifts as a gradual/smooth process. The empirical findings show that taking into account gradual structural shifts matters for the causal linkages between financial development and energy consumption. While the causality analysis which does not account for structural changes supports a causality between financial development and energy consumption only in 4 out of 21 emerging markets, the causality analysis with structural changes provides a causal linkage in half of the sample. This finding is consistent with the fact that emerging markets have experienced structural changes in either finance or energy sectors or both. We also conduct additional analyses which point out that cross-sectional dependency and the quantiles of the distribution matter for the causal linkages. Our results further shed light on the evidence that the economic activity mainly causes the financial development and energy consumption at the highest quantile of distribution in the fast-growing emerging economies.