Time-varying Long-run Income and Output Elasticities of Electricity Demand with an Application to Korea

- Introduced a long-run electricity demand model with smoothly varying income/output elasticity
- Demonstrated that conventional fixed-coefficient models overestimate income/output elasticities
- Estimated using a flexible semiparametric technique and applied to Korean sectoral data
- Found that Korean elasticities have increased dramatically over the past few decades
- Found substantial forecasting improvement using the time-varying approach over the conventional approach

It is widely accepted that long-run elasticities of demand for electricity are not stable over time. We model long-run sectoral electricity demand using a time-varying cointegrating vector. Specifically, the coefficient on income (residential sector) or output (commercial and industrial sectors) is allowed to follow a smooth semiparametric function of time, providing a flexible specification that allows more accurate out-of-sample forecasts than either fixed or discretely changing regression coefficients. We fit the model to Korean data over 1995:01-2012:12 for the residential sector and 1985:01-2012:12 for the commercial and industrial sectors. The rapid development of Korea over this period provides a very clear case for allowing the coefficient on income/output to vary over time, but the essential modeling strategy is widely applicable.