Financial development and its moderating role in environmental Kuznets curve: evidence from Pakistan

The nexus among real income, energy consumption, financial development, and carbon emission has broadly conferred area in energy and environmental literature. However, there is no study in the literature which investigates the moderating role of financial development between real income, energy consumption, and CO₂ emission in Pakistan. This study reveals the role of financial development as a moderator in the conventional environmental Kuznets curve (EKC). To achieve the objectives of this study, two approaches are employed, (i) with main effects and (ii) with interaction variables, using autoregressive distributed lag (ARDL) bounds testing approach in the case of Pakistan covering the period 1970 to 2016. Findings of the empirical analysis confirm the EKC hypothesis in the first case (without interaction effect) and our second estimations (with interaction effect) show that financial development significantly moderates the association of real output with CO₂ emission (both for the long run and short run). The negative effect of financial development on carbon emission reveals to efficacious energy management with effective environmental performance. More precisely, the results of second estimations reveal that all three interaction variables are statistically significant but the EKC curve is no more. Thus, the current study proposes that the moderating effect of the financial sectors may be the possible reason which has been ignored by prior researchers and they found mix results regarding the existence of EKC in Pakistan. In addition, the Granger causality test confirms the feedback effect between real income and carbon emission and one-way causality from all the three interaction variables and financial development to CO₂ emission. Lastly, this study posits some important policy inferences in the perspective of new economic policy formation in Pakistan.