Investigating the causal relationship between financial development and carbon emission in the emerging country

Abstract

The current study investigates the causality relationship between financial development and carbon dioxide (CO2) emission in Bahrain by adopting time series data from 1980–2018. The vector error correction model (VECM) is employed as an appropriate model in order to analyse the data. While the augmented Dickey-Fuller (ADF) test was used in order to detect the stationary variables. However, the domestic per capita has been used as a proxy of economic growth, while financial development is measured by domestic credit provided by the financial sector. The results indicate that there is a long-term association amongst all intended variables at a 5% significant level. Meanwhile, only financial development has an impact on carbon emission in the short term. For the Granger causality test, only financial development and population led positive impact on CO2, while carbon emission does not Granger-cause financial development and population. However, the study findings did not support the hypothesis of the environmental Kuznets curve (EKC), and these findings are in line with other previous empirical findings (Saidi & Mbarek, 2017). These findings are essential and contribute to policymakers controlling credit policies that confirm that the loans availed by the financial sector to the domestic firms are used as friendly machinery tools for the environment that can decrease CO2 emission.