Economic Research and Perspectives

Economic Research and Perspectives

A Dynamic and Comparative Analysis of the Impact of Financial Development on Energy Demand in Developing and Advanced Countries: Emphasizing the Roles of Stock and Money Markets

Authors
Zeinab Jahani 1
Ali Falahati 2
Jamal Soleimani 3
1 MSc, Department of Economics, Faculty of Social Sciences, Razi University, Kermanshah, Iran
2 Associate Professor, Department of Economics, Faculty of Social Sciences, Razi University, Kermanshah, Iran
3 MSc, Department of Economics, Faculty of Economics, Allameh Tabataba’i University, Tehran, Iran
10.48311/ecor.2025.24058
Abstract
Energy underpins production and growth, yet rising demand amid volatile prices makes it essential to clarify how finance shapes energy use across development stages. This study compares the effects of stock‑market and money‑market development on per‑capita energy demand for  developing and  advanced economies over –. Composite indices for each financial channel are constructed via principal component analysis on standardized indicators, rescaled. Dynamic panels with country and year fixed effects are estimated separately by development group using two‑step system GMM with Windmeijer correction; the lagged dependent variable, income, and the financial indices are treated as endogenous and instrumented with appropriate lags in levels and differences, using collapsed, depth‑restricted matrices. Controls include real GDP per capita, real energy prices, and FDI inflows, with log transformations where relevant. Specification validity is assessed by AR()/AR(), Hansen J, and difference‑in‑Hansen tests. Results show strong persistence in energy demand and a positive income effect in both groups. Oil prices raise consumption in developing economies—consistent with subsidies and limited substitutes—while prices curb demand in advanced economies. Money‑market development reduces energy use, whereas stock‑market development initially expands energy‑intensive activity but ultimately supports efficiency. Nonlinearities are salient: stock‑market effects are U‑shaped in developing economies and inverted‑U in advanced ones; money‑market depth displays an inverted‑U in both groups. Policy should therefore sequence financial reforms to steer capital toward low‑carbon innovation in developing countries and sustain robust regulation and technology deployment in advanced economies, thereby accelerating the energy transition.
 
Aim and Introduction:
Energy plays a central role in economic activity, underpinning production and influencing overall GDP. In recent decades, global energy consumption has risen considerably, underscoring energy’s pivotal contribution to economic growth and sustainable development. However, the growing demand for energy—amidst constrained supply and volatile prices—has intensified the need to understand its determinants, particularly across different stages of economic development.
Among these determinants, financial development has garnered increasing attention for its potential to optimize resource allocation, enhance investment flows, and facilitate capital mobility. When well-functioning money markets (e.g., banking and short-term credit) and capital markets (e.g., equity financing) interact efficiently, they can ease access to capital for firms and individuals. This, in turn, may influence production dynamics, capital structures, and energy consumption patterns.
However, the impact of financial development on energy demand is not always linear. In early stages of economic development, financial expansion often stimulates investments in energy-intensive sectors, thereby increasing overall energy consumption. As financial systems mature, the adoption of advanced technologies and stronger institutional frameworks may promote efficiency and support a transition to cleaner energy sources.
Although prior research has explored the interconnections among economic growth, energy consumption, and financial development, it has often failed to distinguish between the distinct effects of money and stock markets. Moreover, structural disparities between developing and advanced economies—such as differences in institutional quality, energy infrastructure, and technological capacity—render a uniform analysis insufficient.
Against this backdrop, the main objective of this study is to examine and compare the influence of financial development, via stock and money markets, on energy demand across  developing and  developed countries from  to . Specifically, it investigates whether these effects vary by development stage and whether the relationships exhibit non-linear patterns—such as U-shaped or inverted U-shaped trends.
 
Methodology:
We conduct a comparative dynamic-panel analysis for  developing and  advanced countries over –. The dependent variable is per-capita energy demand. To capture financial development along two distinct channels, we build composite indices for the stock-market and the money-market using principal component analysis (PCA) on standardized indicators; the first principal component is retained and rescaled for interpretability. We estimate country- and year-fixed-effects models of the form:
via two-step system-GMM (Arellano–Bover/Blundell–Bond) with Windmeijer-corrected standard errors. Endogenous regressors (the lagged dependent variable, financial indices, and income) are instrumented with their appropriate lags in levels and differences; the instrument matrix is collapsed and lag-depth-restricted to prevent instrument proliferation. The control vector XitX_{it} includes real GDP per capita, real energy prices, and FDI inflows; variables are log-transformed where appropriate. We assess specification validity using Arellano–Bond AR()/AR() tests for serial correlation and Hansen J (and difference-in-Hansen) tests for over-identifying restrictions. Non-linearities are probed by including squared terms of the financial indices and interpreting the implied turning points within each country group. All models are estimated separately for developing and advanced economies, with robustness checks using alternative instrument sets and proxy definitions.
 
Findings:
The empirical results reveal that national income significantly and positively affects energy demand in both developing and developed countries. Additionally, energy consumption patterns show strong persistence, with current demand heavily influenced by past consumption levels.
Oil prices have contrasting effects across development levels. In developing countries, energy consumption tends to rise with increasing oil prices, likely due to extensive subsidies and limited access to alternative energy sources. In contrast, higher energy prices in developed countries are associated with reduced consumption, reflecting greater price responsiveness and availability of cleaner energy technologies.
The development of money markets is associated with a reduction in energy demand in both country groups. Conversely, the initial phases of stock market development often lead to increased energy consumption due to investment in energy-intensive industries. However, as financial systems mature and institutional and technological advancements occur, the stock market increasingly promotes energy efficiency.
These results confirm the presence of non-linear relationships between financial development and energy demand. Stock-market development is U-shaped in developing economies but inverted-U in advanced economies, whereas when channeled through money-market depth, the association is inverted-U in both groups consistent with an initial expansion of energy intensive activity followed by efficiency gains as institutions and technologies mature.
 
Discussion and Conclusion:
The relationship between financial development and energy demand is multifaceted and mediated by institutional and technological factors. In the early stages of development, enhanced access to credit and expanding equity markets may support growth in energy-intensive sectors, leading to increased consumption. Over time, however, more mature financial systems—characterized by stronger regulatory frameworks and technological innovation—facilitate investments in cleaner, more efficient energy alternatives.
The results also suggest that the impacts of money and stock markets on energy consumption are not always aligned and vary according to a country’s level of development. In some cases, an inverted U-shaped relationship emerges, indicating that while financial deepening may initially raise energy use, it eventually contributes to greater energy efficiency as markets evolve.
Policymakers in developing countries should implement financial reforms that channel credit into low-carbon and innovative sectors. In advanced economies, the emphasis should be on maintaining robust regulatory frameworks and supporting the technological infrastructure needed to allocate capital effectively to sustainable energy systems.
In conclusion, this study underscores the importance of tailoring financial and energy policies to the specific development stage of each country. Financial development should serve not merely as a driver of economic expansion but as a strategic lever for enabling the transition to sustainable energy use.
Keywords
Developed and Developing Countries, Energy Demand, Financial Development, Generalized Method of Moments (GMM), Money Market, Stock Market

Subjects

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