On the temporal causal relationship between energy consumption, real income, and prices: Some new evidence from Asian-energy dependent NICs based on a multivariate cointegration vector error-correction approach

Departing from previous studies on the causal relationship between energy consumption and economic growth, this paper illustrates how the finding of cointegration (i.e., long-term equilibrium relationship) between these variables, may be used in testing Granger causality. Based on the most recent Johansen's multiple cointegration tests preceded by various unit root or nonstationarity tests, we test for cointegration between total energy consumption, real income, and price level of two highly energy dependent East Asian NICs: Korea and Taiwan. Nonrejection of cointegration between variables rules out Granger noncausality and implies at least one way of Granger causality, either unidirectional or bidirectional. Secondly, by using a dynamic vector error-correction model, we then analyze the direction of Granger causation and hence the within-sample Granger exogeneity or endogeneity of each of the variables. Thirdly, the relative strength of the causality is gauged (through the dynamic variance decomposition technique) by decomposing the total impact of an unanticipated shock to each of the variables beyond the sample period, into proportions attributable to shocks in the other variables, including its own, in the multivariate system. Finally, these response paths of shocks to the system are traced broadly indicate that all three variables are cointegrated and mutually causal. The Granger-causal chain implied by our evidence tends to suggest that although all these variables are endogenous (i.e., they all share the brunt of adjustment to reestablish the long-term equilibrium), relatively in these two highly energy-dependent economies, in line with expectations, it is the rate of price change that leads to the change in energy consumption, which then leads on to the change in economic growth. Overall, shocks to the system seemed to have had a more sustained if not pronounced effect in Korea than in Taiwan. (C) 1997 Society of Policy Modeling. Published by Elsevier Science Inc.