Financial Development and Energy Consumption in Turkey: Empirical Evidence from Cointegration and Causality Tests

Financial Development and Energy Consumption in Turkey: Empirical Evidence from Cointegration and Causality Tests

Murat Çetin (Namık Kemal University, Turkey), Eyyup Ecevit (Erciyes University, Turkey), Fahri Seker (Bozok University, Turkey) and Davuthan Günaydin (Namık Kemal University, Turkey)
DOI: 10.4018/978-1-4666-7484-4.ch018
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Abstract

This chapter investigates the cointegration and causal relationship between financial development and energy consumption in the case of Turkey over the period 1960-2011. In doing so, the ARDL bounds testing and Johansen-Juselius approaches to cointegration and Granger causality test based on vectorerror correction model are employed. The empirical results show that the series are cointegrated. The empirical results also show a positive and statistically significant relationship between financial development and energy consumption in the long run. In addition, a unidirectional causality running from financial development to energy consumption is found in the short and long run. Thus, this chapter provides an empirical evidence that financial development is a determinant of energy consumption in Turkey. This chapter also presents some implications for Turkey's energy policy.
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Introduction

Investigating the determinants of demand for energy has been a major focus of research topic in developing countries for several reasons. Firstly, since energy is a key factor of the production, its resources may affect economic growth and development of a country (Squalli, 2007; Stern, 2010). Secondly, some developing countries such as Turkey, China and India have been growing rapidly. This increases the demand for energy in those countries. As indicated in Turkey report presented by US Energy Information Administration (2013) Turkey has witnessed the fastest growth in energy demand over the last two years in the OECD. In addition, Turkey which imports majority of its oil, natural gas and hard coal supplies is expected to double energy demand over the next decade. Thus, it is very important issue to deal with the dynamics of energy consumption for Turkish economy.

Turkey has also implemented a macroeconomic strategy regarding cautious structural and fiscal reforms since 2002. Through this strategy, Turkey has been one of the major recipients of foreign direct investment (FDI) and integrated with the globalized world economy accelerated by Turkey’s EU accession process. One of the main aims of these structural and fiscal reforms is to increase the efficiency and resiliency of the financial sector. These reforms have reinforced the macroeconomic structure of the country. Therefore Turkey has experienced rapid economic growth between 2002 and 2012 with an average annual real GDP growth of 5 percent. These significant improvements in the Turkish economy have also enhanced foreign trade. Turkey’s exports reached USD 151.7 billion by the end of 2013, up from USD 36 billion in 2002 (OECD, 2013; Macroeconomic Outlook Report, 2012). Thus, as well as demand for energy, financial development, economic growth and foreign trade appear as important policy dynamics of Turkish economy.

In recent years, the role of financial development as a determinant of energy consumption has been investigated in energy literature (Sadorsky, 2010a; Shahbaz & Lean, 2012; Islam, Shahbaz, Ahmed & Alam, 2013; Mudakkar, Zaman, Shakir, Arif & Naseen, 2013; Coban & Topcu, 2013). However, as seen from Table 1, none of the previous studies examine this relationship in the case of Turkey in spite of the considerable increases both in its financial development and demand for energy in the last decade. Therefore, this study basically investigates the long-run and causal relationship between financial development and energy consumption by adding real income and trade openness as potential determinants to function for energy consumption in Turkey over the period 1960-2011.

Key Terms in this Chapter

Vector Error Correction Model: Generally, after examining the long-run relationship between the variables, standard Granger causality based on VAR system or Granger causality based on vector error correction model are used to determine the direction of causality between the variables. If there is a cointegration between the variables, vector error correction model can be used. This method is known as augmented Granger causality test. In this approach, error correction term (ECT) is added to the VAR system. The significance t-statistic on the parameter of ECT indicates that there is an evidence of the existence of the long run relationship and long run causality between the variables.

Turkey: Turkey is one of the developing countries which are rapidly growing such as China and India. Turkey has been one of the major recipients of FDI and integrated with the globalized world economy accelerated by Turkey’s EU accession process. It has experienced rapid economic growth between 2002 and 2012 with an average annual real GDP growth of 5 percent. In addition, Turkey’s foreign trade has developed from the year of 2002. Nowadays, energy, financial development, economic growth and foreign trade are seen as crucial policy areas in Turkey.

Energy Consumption: Energy consumption is the consumption of energy or power. Per capita or total energy use can be employed in empirical analyses.

Financial Development: Financial development means some improvements in producing information about possible investments and allocating capital, monitoring firms and exerting corporate governance, trading, diversification, and management of risk, mobilization and pooling of savings, easing the exchange of goods and services. These financial functions affect savings andinvestment decisions, and technological innovationsand hence economic growth.

ARDL Bounds Testing: ARDL bounds testing approach is a cointegration method developed by Pesaran et al. (2001) to test presence of the long run relationship between the variables. This procedure, relatively new method, has many advantages over the classical cointegration tests. Firstly, the approach is used irrespective of whether the series are I(0) or I(1). Secondly, unrestricted error correction model (UECM) can be derived from the ARDL bounds testing through a simple linear transformation. This model has both short and long run dynamics. Thirdly, the empirical results show that the approach is superior and provides consistent results for small sample.

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