The relationship between financial development and energy consumption has newly started to be discussed in energy economics literature. This paper investigates this issue in the EU over the period 1990–2011 by using system-GMM model. No significant relationship is found in the EU27. The empirical results, however, provide strong evidence of the impact of the financial development on energy consumption in the old members. Greater financial development leads to an increase in energy consumption, regardless of whether financial development stems from banking sector or stock market. By contrast, we find for the new members that the impact of financial development on energy consumption depends on how financial development is measured. Using bankindex the impact of financial development displays an inverted U-shaped pattern while no significant relationship is detected once it is measured using stockindex.
In the European Union (2020) energy strategy, energy-efficiency is listed among five priorities. The European Commission (2010) Energy report propounds that the EU is aiming for a 20% cut in Europe's annual primary energy consumption by 2020. For this purpose, it is very crucial to determine the dynamics of energy consumption in the EU. This learning also helps to understand how energy demand in the EU countries is going to change in the future.
The relationship between energy consumption and economic growth is certainly well-documented both theoretically and empirically (see, for example, Apergis and Payne, 2010, Apergis and Tang, 2013, Narayan and Smyth, 2008, Narayan et al., 2010 and Sari and Soytas, 2007, etc.). There also exist several studies exploring this issue in the case of the EU (see, for example, Ciaretta and Zarraga, 2010, Menegaki, 2011 and Pirlogea and Cicea, 2012). On the other hand, a consensus has emerged about the vital role of financial development on economic growth in recent years (see, for example, Al-yousif, 2002, Fung, 2009, Kar et al., 2011 and Masten et al., 2008, etc.) and it is also possible to find some empirical evidences from the EU (see, for example, Antonios, 2010, Wu et al., 2010 and Zagorchev et al., 2011).
Over the last three decades, the papers focusing the nexus between energy consumption and economic growth or financial development and economic growth have commonly found a significant relationship. It is therefore rational to anticipate a significant running between financial development and energy consumption as well. Theoretically, Sadorsky (2011) explains how financial development affects energy consumption in three ways (see, for detailed discussion, Sadorsky (2011)). These ways, presented in Table 1, could be named as effect channels. Nonetheless, Sadorsky (2010) points out that the theoretical relationship between the variables in question is unclear, and it could only be resolved through empirical analysis.
This study is probably the first to investigate the dynamic relationship between financial development and energy consumption in the case of the EU. System-GMM model for a panel of twenty seven member states is employed based on annual data ranging from 1990 to 2011. There is no much indication that financial development affects energy consumption in the EU. Nevertheless, when the sample is divided into two parts as the old and the new members, we achieve to obtain expressive results. The empirical results provide strong evidence of the impact of the financial development on energy consumption in the case of the old members. Regardless of whether financial development stems from banking sector or stock market, greater financial development leads to an increase in energy consumption. This finding is consistent with the bulk of the financial development-energy literature (see, for example, Islam et al., 2013, Kakar et al., 2011, Ozturk and Acaravcı, 2013, Sadorsky, 2010, Sadorsky, 2011 and Xu, 2012). Contrary to the old members, we find strong support for the new members that the impact of financial development on energy consumption depends on how financial development is measured. When it is measured using stock market variables, no significant relationship is found. On the other hand, however, when it is measured using banking variables the impact of financial development displays an inverted U-shaped pattern. As similar with Hassan et al. (2011), the inverted U-shaped relationship in emerging countries shows that a well-functioning banking system is a necessary but not a sufficient condition to reach steady economic growth which then triggers energy consumption. Hence, the difference between the newer and the older members strongly implies the role of economic development, which is supported by some empirical evidences from the EU such as Wu et al. (2010), Zagorchev et al. (2011), Pirlogea and Cicea (2012). Furthermore, such a nonlinear relationship may explain why existing energy consumption-growth literature in emerging countries appears to exhibit dissimilar results. Finally, the results of this study contribute to the results of Sadorsky (2011) by suggesting that considering financial development indicators into two parts may yield more effective results if the cross-section unit of the panel shows homogenous structure. In this respect, researchers who will investigate an issue related to energy economics in the EU in the future should take this heterogeneity into account.
