Energy arguably plays a vital role in a country's economic development, and many studies have attempted to test the causality between energy and economic growth. However, no consensus has emerged yet. In the developing world, including Indonesia, the provision for greater access to energy has been suggested by some to help their economies grow and improve the lives of the poor. This study investigates the relationship between energy consumption and economic output (gross domestic product, GDP) by applying an economic method called the vector error correction of pairwise Granger causality model. The tests reveal that no directional flow exists from GDP to energy consumption; we also find no causal relationship between GDP and energy consumption in Indonesia in the long run, although a relationship exists in the short run. However, our tests indicate the presence of a strong statistical relationship between GDP and energy consumption in Indonesia. This finding indicates that there is a possibility for reducing the energy requirement for a certain quantity of GDP without raising the use of other inputs. This implies that energy conservation is a feasible policy tool to reduce production costs and render the Indonesian economy more competitive.
- vector error correction model