Identification and causal analysis of the influence channels of financial development on CO2 emissions

Understanding the influence channels of financial development on CO2 emissions and their causal relationships are necessary for policy makers to reduce CO2 emissions using financial means. These points have not been systematically discussed in previous studies. This paper dynamically identifies five main channels of influence—economic growth, industrialization, foreign direct investment (FDI), technological innovation, and energy consumption—and examines their causal relationships. By adopting a functional-coefficient approach and the Granger causality test based on panel data for 42 countries during 1990–2018, we find that financial development clearly affects CO2 emissions through three channels: industrialization, economic growth, and energy consumption. However, the other channels have only weak influences, and we further confirm the causal relationships among these five channels. Specifically, we confirm three relationships. (1) The impact of financial development on CO2 emissions changes from negative to positive as industrialization and energy consumption increase. (2) Financial development has a positive impact on CO2 emissions when per-capita income is between $1100 and $8100 but a negative impact when per-capita income is less than $1100 or greater than $8100. (3) The economic growth channel is the Granger cause of the energy consumption and technological progress channels, and vice versa. Finally, we discuss the policy implications for reducing CO2 emissions from the perspective of these channels of influence of financial development.