Exploring the relationship between energy use and economic growth with bivariate models: New evidence from G-7 countries

There is a rapidly growing literature on the interaction between energy use and economic development, with many analysts drawing policy conclusions on the basis of Granger causality tests that involve only an energy and an economic variable. This paper attempts to demonstrate empirically that such studies, although useful for certain applications, may be of limited use for policy purposes. After outlining theoretical and methodological issues associated with such approaches, I apply bivariate energy-economy causality tests for Canada, France, Germany, Italy, Japan, the United Kingdom and the United States, using aggregate and sectoral data and three different modern econometric methods. The results, which are often contradictory or economically implausible, illustrate explicitly that one should be cautious when drawing policy implications with the aid of bivariate causality tests on small samples. I therefore underline the importance of utilizing as large sample sizes as possible and using multivariate models, which are closer to economic theory, accommodate several mechanisms and causality channels and provide a better representation of real-world interactions between energy use and economic growth.