The Impact of Energy Consumption and Financial Development on Economic Growth in the United States: An ARDL Bounds Testing Approach

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1 Journal of Busness & Economc Polcy Vol. 2, No. 3; Sepember 2015 The Impac of Energy Consumpon and Fnancal Developmen on Economc Growh n he Uned Saes: An ARDL Bounds Tesng Approach Dr. Hung-Mng Wu Alehea Unversy No. 32, Zhenl Sree, Tamsu Ds., New Tape Cy, Tawan, R.O.C. Absrac Ths sudy nvesgaes he mpac of energy consumpon and fnancal developmen on economc growh usng neo-classcal producon funcon n he case of US. The ARDL (Auoregressve dsrbued lag) bounds esng approach wh addonal varables (energy consumpon and fnancal developmen) s used o nvesgae conegraon durng he perod of n US. The ARDL reveals a conegraon relaonshp among energy consumpon, fnancal developmen, capal and economc growh. Energy consumpon and fnancal developmen reveal shor erm mpacs bu no long-erm mpacs on economc developmen. Capal has shor and long mpacs on economc developmen. Therefore, energy conservaon polces can be mplemened snce energy consumpon only has shor erm effecs on economc growh bu no long erm effecs. The resul also mples ha he US governmen should encourage he fnancal secor o develop a new fnancal polcy or sysem o boos up he process of capalzaon o keep gong economc growh. JEL: C5; Q43 Key words: ARDL; energy consumpon; fnancal developmen; economc growh. 1. Inroducon The mpac of energy consumpon and fnancal developmen on economc growh n he US was explored by usng he neo-classcal producon funcon. Developed counres such as he US have been asked o ake responsbly for envronmenal proecon. The US may be one of world havng hgher echnology o use energy effcenly and has economc growh n he same me. Energy consumpon (envronmen proecon) has been a ho ssue n recen years. Snce 1970 s he relaonshp beween energy consumpon and economc growh have been dscussed (Kraf and Kraf, 1978). Snce hen, many sudes have dscussed he relaonshp beween energy consumpon and economc growh, bu her resuls have been nconclusve. Conclusons dffer because sudes have been performed n dfferen counres, dfferen me perod, dfferen models, and dfferen counres unqueness (Ozurk, 2010; Payne, 2010). Four causal relaonshps beween economc growh and energy consumpon have been proposed. The growh hypohess s ha energy Granger causes oupu, he conservaon hypohess s ha oupu Granger causes energy, he feedback hypohess s ha energy and oupu Granger cause each oher, and he neuraly hypohess s ha energy and oupu do no Granger cause each oher (Payne, 2010). The four hypoheses can be dvded no wo vews: one s ha energy consumpon affecs economc growh, and he oher one s ha energy consumpon does no affec economc growh. If energy consumpon does no affec economc growh, energy conservaon polcy can be used snce may no hur economc growh. The nex queson s he sze of he effec and he duraon of he effec. Sar e al.(2008) appled he ARDL(auoregressve dsrbued lag) bounds esng approach (proposed by Pesaran e al.(2001)) o fnd he amoun of he effec. The ARDL also can esmae he shor run and long run effec. The fnal queson s wheher an mporan varable such as fnancal developmen has been excluded. Fnancal developmen has been dscussed abou affecng economc growh (Kng & Levne, 1993; Odedokun, 1996; Ang, 2008; Wolde-Rufael, 2009; Shahbaz, e.al, 2013). The reason o pu he fnancal developmen n he producon s ha les people easy o ge loan (cheaper cos) n some ems, for example household applances, mobles, house, e al. Therefore, may have a posve effec on economc growh (Mehrara, and Musa 2012). 179

2 ISSN (Prn), (Onlne) Cener for Promong Ideas, USA Therefore, he sudy adds he mporan varables (fnancal developmen and energy consumpon) n neoclasscal producon funcon n he research. The sudy also concern abou he ulzaon of npu (capal), snce he ulzaon rae of capal may no be full n every year n he real world (Klen and Su, 1979). To he bes of my knowledge, hs sudy s he frs emprcal sudy ha uses he varables (economc growh, capal, energy consumpon, and fnancal developmen) wh he advanced and he popular model ARDL bounds esng approach (Pesaran e al., 2001)) and he ulzaon rae of capal o nvesgae conegraon relaonshp among hese varables n US o fnd he long run and shor run effec. The research revealed a conegraon relaonshp among energy consumpon, fnancal developmen, capal and economc growh. Energy consumpon and fnancal developmen revealed shor erm mpacs bu no long-erm mpacs on economc developmen. The capal has shor and long mpacs on economc developmen. Ths mples ha energy conservaon polces should be mplemened because energy conservaon polces only have shor erm effecs on economc growh bu no long-erm effecs. Therefore, he US governmen may connue o promoe more nvesmens on energy effcency research o keep gong economc growh. Ths paper s organzed as follows: Secon 1 s nroducon, Secons 2 s leraure revew, Secon 3 s daa and mehodology, and Secon 4 s emprcal resuls. The las secon s concluson and polcy mplcaons. 2. Leraure Revew Many researches examne he relaonshp beween energy consumpon and economc growh. Accordng o he leraure survey paper of Payne (2010), here are more han one hundred emprcal papers dong he research of he relaonshp beween energy consumpon and economc growh alone up unl 2008 (by publcaon dae). These sudes have obaned very dfferen resuls. Tha s because hey may use he dfferen economerc models, me perods, and counres (Payne, 2010)). The fnancal developmen has been focus on havng he relaonshp wh economc growh n he recen year (Kng & Levne, 1993;Odedokun, 1996; Ang, 2008; Wolde- Rufael, 2009; Shahbaz, e.al, 2013). Therefore, hs leraure revew focuses on wo major fndngs of hese pas sudes. One s energy consumpon- economc growh nexus and he oher one s fnancal developmeneconomc growh nexus. 2.1 Energy Consumpon- Economc Growh Nexus In he early 1970s, Kraf and Kraf (1978) performed he orgnal sudy of he energy-growh relaonshp. They repored a undreconal causaly relaonshp runnng from GNP ( Gross Naonal Produc ) o energy consumpon bu no vce versa. Eden& Hwang (1984) apply Sms echnque and use he updaed daa US ( ) o reexamne he relaonshp beween energy consumpon and GNP. They fnd ha here s no relaonshp beween energy consumpon and GNP. Boh of hese sudes used bvarae models, whch may lose mporan varable(s) and oban based resuls. Sern (1993) uses mulvarae VAR model by addng capal and employmen varable for daa for he USA. He fnds ha energy consumpon Granger causes GDP. Ewng e al. (2007) uses he generalzed varance decomposon approach o dsaggregae energy consumpon. They fnd ha naural gas, coal, and fossl fuel do affec oupu. Lee& Chen, (2010) use an aggregae producon funcon o examne he dynamc relaonshp among energy consumpon, capal sock, and oupu n G-7 counes. Varance decomposons also revealed ha he effec of energy consumpon on oupu s overesmaed when he ulzaon rae of capal n he US gnored. Therefore, hs sudy also apples he ulzaon rae of capal n hs research. The drawback of he sandard Granger es s ha needs a dfferencng o varables ha are non-saonary. The dfferencng may remove some mporan long-run nformaon ha s very mporan for polcy makers; he drawback has been solved by conegraon model. Yu &Jn (1992) employ conegraon model and fnd here s no long run relaonshp beween energy consumpon and economc growh n US case. However, bvarae analyss may cause bas because excludes mporan varable(s). Sern (2000) use conegraon analyss o exend hs prevous sudy (mulvarae VAR model; Sern, 1993) n US. He fnds ha he resuls are smlar o hs prevous resuls (energy Granger causes oupu) and here s a long run relaonshp beween energy and oupu. In Oh & Lee, (2004), a vecor error correcon model (VECM) revealed no shor erm causal relaonshp beween oupu and energy bu denfed a long-run causal relaonshp beween oupu and energy n Korea. A lmaon of he VECM model s ha all he varables n he VECM model needs o be he same order of negraon. Anoher drawback of he VECM model s ha varables mus be assgned he same lag-lenghs. The ARDL model can avod hese wo drawbacks of he VECM model (Umer, 2014). 180

3 Journal of Busness & Economc Polcy Vol. 2, No. 3; Sepember Fnancal Developmen-Economc Growh nexus Recen sudes have revealed a relaonshp beween fnancal developmen and economc growh (Kng & Levne, 1993; Odedokun, 1996; Ang, 2008; Wolde-Rufael, 2009; Shahbaz, e.al, 2013). Kng & Levne (1993) argued ha, as fnancal sysems mprove, nnovaon and economc growh mprove. Odedokun (1996) use he convenonal neo-classcal producon funcon (addng he fnancal developmen varable) model n LDCs (leas developed counres) by usng annual daa for 71 counres. Fnancal developmen had a posve effec on economc growh n approxmaely 85% of hese counes. Ang (2008) use he ARDL bounds approach o fnd ha fnancal developmen has posve effec on oupu n Malaysa. In Wolde-Rufael (2009), he Granger causaly model (Toda and Yamamoo (1995) procedure) revealed ha fnancal developmen Granger causes economc growh n Kenya. Shahbaz e.al (2013) use ARDL bounds esng approach and fnd fnancal developmen have posve effec on economc growh n Chna. Granger causaly analyss furher revealed a wo-way (bdreconal) causal relaonshp beween fnancal developmen and economc growh. Alhough many sudes have nvesgaed he energy consumpon- economc growh nexus and he fnancal developmen-economc growh nexus, very few sudes have examned he relaonshp among energy consumpon, fnancal developmen, and economc growh wh producon funcon. Therefore, hs sudy performed an n-deph analyss of he mpac (boh n shor run and long run mpac) of energy consumpon and fnancal developmen on economc growh wh producon funcon and an advanced mehodology-ardl bound esng procedure for he emprcal sudy of US. 3. Daa and Mehodology Recen sudes have argued ha energy s an mporan producon npu (Sern, 1993, 2000; Ghal and El-Sakka, 2004; Lee and Chang, 2008; Lean and Smyh, 2014). Fnancal developmen s also consdered an mporan npu (Odedokun, 1996; Anwar and Nguyen, 2011; Shahbaz, e.al,, 2013; Shahbaz, e.al, 2014). Accordng o he exsng leraure, he mpac of energy consumpon and fnancal developmen on economc growh s emprcally examned by he followng model: ln y 0 1 ln ku 2 ln ec 3 ln fd (1) where y s GDP per capa a consan prce(consan 2005 US$) (a proxy for economc growh), ku s capal per capa (Gross fxed capal formaon (consan 2005 US$) ),whch s wh full ulzaon rae, ec s energy consumpon n kg of ol equvalen per capa, fd s fnancal developmen proxes by real domesc cred o prvae secor per capa (usng Domesc cred o prvae secor (% of GDP) o mulple by GDP curren prce, dvde by CPI prce ndex and dvde by populaon), s a saonary error erm. All varables are ook logarhm (wren by ln). All daa were obaned from World Developmen Indcaors (WDI, by he World Bank) wh he excepon of ulzaon rae of capal, whch was obaned from he Board of Governors of he Federal Reserve Sysem (hps://research.slousfed.org/fred2/). Mos emprcal sudes have focused on he full ulzaon of capal. However, he calculaon for he ulzaon rae of capal mus assume ha capal may no be fully ulzed every year (Klen and Su, 1979; Lee& Chen, 2010)). Therefore, hs sudy modfes Eq. (1) of he aggregae producon funcon o be as follows: ln y 0 1 ln k 2 ln ec 3 ln fd (2) Where k = * ku and Is he rae of capacy ulzaon? The auoregressve dsrbued lag model (ARDL) was used o es for conegraon and o esmae long-run and shor-run dynamcs. The ARDL model has an advanage o handle he varables (he varables may nclude a mxure of saonary and non-saonary me-seres, for example, negraed of order (1) or (0)). Anoher advanage of he model s ha s easy o mplemen and nerpre snce nvolves only a sngle-equaon arrangemen. Anoher advanage s ha dfferen varables of he model can be assgned dfferen lag-lenghs (Pesaran and Shn 1999; Pesaran e al. 2001). In order o fnd he long run and shor run relaonshp, he dynamc error correcon model has been used, whch derved by ARDL model. The model s presened as follows: 181

4 ISSN (Prn), (Onlne) Cener for Promong Ideas, USA ln y n1 1 ln y ln y ln k 2 1 n2 0 ln k ln ec 3 1 n3 0 ln fd 4 lnec 1 n4 0 ln fd Where,φ,γ and η are shor run parameers and λ 1 oλ 4 are long run parameers. To es conegraon, he null hypohess s se o H 0 : λ 1 =λ 2 =λ 3 =λ 4 =0 agans he alernave hypohess H 0 s no rue. A rejecon of he null hypohess mples ha he model has a long-run (conegraon) relaonshp. Pesaran e al. (2001) provdes he upper bounds and lower bounds on dfferen numbers of varables o be he crcal values. The upper bound (UB) s based on he assumpon ha all varables are I(1) and he lower bound (LB) apples f he seres are I(0). An F- sasc above he UB ndcaes ha has conegraon. An F-sasc below he LB ndcaes ha here s no conegraon. If he F-sasc falls beween he UB and LB, he es s nconclusve. The Akake Informaon Creron (AIC) was used o selec he orders of he lags for he specfcaon n he ARDL model. AIC s one of popular model selecon creron. Even hough has a rsk of over-fng he model bu I would no under-f he model. The lag lengh ha mnmzes AIC s hen seleced. Afer he suable lag srucure for Eq. (3) has been seleced, Eq. (3) mus be esed o ensure ha s error erm s serally ndependen. Then, he bounds es s used o es he model for wheher here s a long run relaonshp beween hese varables. If a long run (conergraon) relaonshp s observed, we can esmae he long run model (levels model) and he shor run model (convenonal error-correcon model). If a long run (conegraon) relaonshp among hese varables s denfed, all of he frs dfferences of he varables n he Eq. (3) are equal o zero, for example, ln y = ln k ln = ln ec = ln fd = 0. And he long run model can be formulaed as he followng form: y 1 2 ln k 3 ln ec 4 ln fd 1...(4) Where, he long run coeffcens 1 =- 0 /λ 1 ; 2 = -λ 2 /λ 1 ; 3 = -λ 3 /λ 1 ; 4 = -λ 4 /λ 1, and 1 s he random error. To esmae he shor run relaonshp, he convenonal error correcon model verson model from he ARDL model n Eq. (3) s used as follows: ln n1 n2 n3 n4 y 2 2ln y 2lnk 2lnec 2 ln fd ECM (3) (5) The coeffcen of he error correcon erm (ECM -1 ) n Eq. (5) s he speed of adjusmen from he shor-run o he long-run, whch s expeced o be negave and sascally sgnfcan. The model has been esed by he dagnosc ess ha are seral correlaon LM es for seral correlaon, normaly es for normaly, auoregressve condonal heeroskedascy es and whe heeroskedascy es for heeroskedascy, and Ramsey RESET es for he funconal form. Sably ess (cumulave sum of recursve resduals (CUSUM) and cumulave sum of squares of recursve resduals (CUSUMSQ)) are also used o es he goodness of f of he ARDL model. 4. Emprcal Resuls The ARDL model used for emprcal analyss was consruced usng Evews 9 economerc sofware. Snce he ARDL model only can be used n he varables are negraed of I(0) or I(1) (Pesaran e al. 2001), un roo ess have o be used o make sure all he varables are no negraed of I(2) or hgher. The sudy used wo popular un roo ess, he augmened Dckey-Fuller (ADF) (Dckey and Fuller, 1979) and Phllps Perron (PP) (Phllps and Perron, 1988) ess. Table 1 shows he un roo ess resuls. All varables n he levels are no saonary bu all varables n negraed of order 1 or I(1), frs dfference, are saonary. The bound es was used o evaluae conegraon. And he resul of bound es s shown n Table 2. In he Table 2, he value of k (he number of all varables are k+1) s 3 n he model ha he research used. The F-sascs s 7.14 and hgher han upper crcal bound 5.61(1% sgnfcance level), whch ndcaes a long erm relaonshp among economc growh, energy consumpon, fnancal developmen, and capal durng n US. 182

5 Journal of Busness & Economc Polcy Vol. 2, No. 3; Sepember 2015 Varable Table 1: Un Roo Tess ADF es PP es (-Sasc) (adjused -Sasc) Level Consan Whou Trend Consan Wh Trend Consan Whou Trend Consan Wh Trend ln y ln k ln ec ln fd Frs Dfference ln y -5.02* -5.05* * -4.93* ln k -6.08* -6.01* -6.06* * ln ec * -4.91* * -4.80* ln fd * -4.95* * -4.97* Noes: * denoes sgnfcance a he 5% level. Table 2: Resuls of Bounds Tes F-sascs k Sgnfcance Level Bound Crcal values I(0) I(1) % % % The ARDL (5, 1, 1, 5) model s seleced by Akake nfo creron (AIC). The model can esmae he coeffcens of he long-run relaons and he shor run relaons. Table 3 presens he esmaed long run coeffcens and he shor run coeffcens. The long run coeffcen of energy consumpon s and s no sgnfcan (p value s 0.2 whch s greaer han 5%), all else beng consan, whch means ha conservave energy polcy wll no affec US economc growh n he long run. The coeffcen of fnancal developmen s 0.10 and s nsgnfcan (p value s 0.24 whch s greaer han 5%) n he long run. Ths ndcaes ha fnancal developmen does no affec long erm economc growh. The coeffcen of capal s 0.57 and s sgnfcan (p values s close o 0 whch s less han 5%). Tha s, a 1 per cen ncrease n capal ncreases economc growh by approxmaely 0.57 percen. Table 3 shows he resuls obaned when he convenonal error correcon model s used o esmae he shor run relaonshp. The resul suggess ha he energy consumpon has shor run mpac on economc growh because he coeffcen of lag one s posve and sgnfcan (p value 0.03 s less han 5%). The coeffcen of capal s 0.16, posve and sascally sgnfcan. Tha s, capal posvely affecs economc growh. The coeffcen of fnancal developmen also has he expeced posve sgn and sgnfcance a 5%. The coeffcen of ECM (-0.15) s negave and very sgnfcan, whch suggess ha nearly 15% of any devaon from he long-run equlbrum s correced whn one year. Dagnosc ess of he model are performed o evaluae seral correlaon (seral correlaon LM), normaly (normaly es), heeroskedascy (auoregressve condonal heeroskedascy and whe heeroskedascy), and funconal form (Ramsey RESET Tes) n Table 3. The dagnosc es resuls sugges ha here s no seral correlaon, auoregressve condonal heeroskedascy and whe heeroskedascy a he 5% sgnfcance level. The dagnosc es resuls also reveal normal resdual erms. The Ramsey rese es suggess ha he model appears well specfed. 183

6 ISSN (Prn), (Onlne) Cener for Promong Ideas, USA Table 3: Sascal oupu for long run shor run model and dagnosc ess Long run model coeffcens Regressor Coeffcen p-value consan 7.14 <0.01 * ln k 0.57 <0.01 * ln ec ln fd Shor run model coeffcens Regressor Coeffcen p-value ln k 0.16 <0.01 * ln ec ln ec(-1) * ln fd * ECM <0.01 * Dagnosc ess (p-value) Seral Correlaon LM ( 0.09) Normaly Tes ( 0.66) ARCH Tes ( 0.18) Heeroscedscy Tes (0.08) Ramsey RESET Tes ( 0.1) Noes: * denoes sgnfcance a he 5% level. The sably of he esmaed model was esed by calculang he cumulave sum of recursve resduals (CUSUM) and cumulave sum of squares of recursve resduals (CUSUMSQ). Boh hese plos n Fgs. 1 and 2 are n he crcal bounds a 5% sgnfcance level, whch ndcaes ha he esmaed model s sable n he research perod. Plo of Cumulave Sum of Recursve Resduals The sragh lnes represen crcal bounds a 5% sgnfcance level Fgure 1: CUSUM Plos for Sably Tess Plo of Cumulave Sum of Squares of Recursve Resduals The sragh lnes represen crcal bounds a 5% sgnfcance level. Fgure 2: CUSUMSQ Plos for Sably Tes 5. Conclusons and polcy mplcaons Ths sudy examned he mpac of energy consumpon, fnancal developmen, and capal on US economc growh durng

7 Journal of Busness & Economc Polcy Vol. 2, No. 3; Sepember 2015 The ARDL bounds esng model was used n neoclasscal producon funcon o denfy shor-erm and longerm relaonshps among hese varables. The producon funcon revealed a large dfference from prevous research. Tha s, he mporan varable capal has been concerned abou ha capal s no fully ulzed each year. The novel conrbuon of he sudy s he emprcal analyss of he mpac of energy consumpon and fnancal developmen on US economc growh wh he ulzaon of capal n producon funcon by ARDL bounds esng model. The analyss revealed a conegraon relaonshp among energy consumpon, fnancal developmen, capal, and economc growh. The es suggess ha here s a posve mpac of energy consumpon on economc growh only n shor run bu no n he long run. In he long run, follows he neuraly hypohess (Payne, 2010) n he US emprcal sudy. Ths mples ha energy conservaon polcy wll no have long-erm negave effecs on U.S. economc growh. The US may connue o develop he energy effcency echnologes o manan he economc growh of US n he long run. Fnancal developmen posvely affecs economc growh n he shor erm bu no n he long erm. Therefore, he US governmen should encourage he fnancal secor o develop a new fnancal polcy or sysem o boos up he process of capalzaon and o produce a sound energy nfrasrucure. Fnancal developmen would hen have boh long-erm and shor-erm posve effecs on economc growh. Capal posvely affecs economc growh and s a very mporan npu of economc growh boh n shor run and n long run. The capal has a respeced resul and follows he producon heory. Ths mples ha he US governmen should encourage people o nves more n he capal o manan he US economc growh. Furher sudes are needed o compare cross seconal daa. Tme seres daa are also needed for polcy analyses of a sngle counry. Ths sudy used me seres daa (annual daa) for analyss of U.S. polcy. However, because of he degree of freedom, me seres daa canno nclude all mporan varables (for example, expor, governmen spendng, and oursm and so on) whch may affec he economc developmen (Smyh & Narayan, 2014)). To ncrease he number of mporan varables, fuure sudes may use hgh frequency daa f all he daa are avalable. For example, ndusral producon ndex monhly daa may be used as an alernave o GDP. References Abosedra, S., Baghesan, H., New evdence on he causal relaonshp beween Uned Saes energy consumpon and gross naonal produc. Journal of Energy and Developmen 14 (2), Ang, J. B. (2008). Wha are he mechansms lnkng fnancal developmen and economc growh n Malaysa?. Economc Modellng, 25(1), Anwar, S., & Nguyen, L. P. (2011). Fnancal developmen and economc growh n Venam. Journal of Economcs and Fnance, 35(3), Cheng, B., An nvesgaon of conegraon and causaly beween energy consumpon and economc growh. Journal of Energy Developmen 21, Denson, E.,1985. Trends n Amercan Economc Growh, Brookngs Insuon. Washngon, DC. Dckey, D. A., & Fuller, W. A. (1979). Dsrbuon of he esmaors for auoregressve me seres wh a un roo. Journal of he Amercan sascal assocaon, 74(366a), Eden, S. H., & Hwang, B. K. (1984). The relaonshp beween energy and GNP: furher resuls. Energy Economcs, 6(3), Ewng, B. T., Sar, R., & Soyas, U. (2007). Dsaggregae energy consumpon and ndusral oupu n he Uned Saes. Energy Polcy, 35(2), Ghal, K.H., El-Sakka, M.I.T., Energy use and oupu growh n Canada: a mulvarae conegraon analyss.energy Economcs 26 (2), Kng, R. G., & Levne, R. (1993). Fnance, enrepreneurshp and growh. Journal of Moneary economcs, 32(3), Klen, L. R., & Su, V. (1979). Drec esmaes of unemploymen rae and capacy ulzaon n macroeconomerc models. Inernaonal Economc Revew, Kraf, J., Kraf, A., Relaonshps beween energy and GNP. Journal of Energy and Developmen 3, Le, Km-Song and Hassan, Kamrul and Gasbarro, Domnc and Cullen, Gran, The Relaon beween Fnancal Developmen, Energy Consumpon and Economc Growh: Emprcal Evdence for he Uned Saes (Augus 20, 2014). 27h Ausralasan Fnance and Bankng Conference 2014 Paper. Avalable a SSRN: hp://ssrn.com/absrac= or hp://dx.do.org/ /ssrn

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