Cointegration of electricity consumption and GDP in the presence of smooth structural changes

Highlights: • We estimate a long-run demand function of energy consumption. • We use an ADL model with the Fourier function to capture discrete changes in policy. • Controlling for such changes using FADL model proves to be important. • More countries are cointegrated when the Fourier function is included. • Price and income elasticities are similar between old and new EU countries. This paper analyzes the cointegration of electricity consumption, prices, and GDP as well as the long-run price and income elasticities for a sample of European Union (EU) countries. We control for smooth structural changes in the data using recently developed unit root and autoregressive distributed lag (ADL) cointegration tests, which approximate an unknown number of smooth breaks with a flexible Fourier function. Structural breaks in electricity consumption may exist in EU countries because of activities associated with the European Energy Union and country-specific idiosyncracies. Our results indicate that the Fourier cointegration test rejects the null hypothesis of no cointegration more often in comparison to the standard ADL test. Elasticity estimates show clear differences between old and new member states when structural breaks are ignored, but less so when using structural breaks methods.