Carbon neutrality targets, optimal environmental management strategies & the role of financial development: New evidence incorporating non-linear effects and different income levels

Abstract

Financial development has been found to have mixed effects on CO2 emissions. One reason appears to be the relationship is not linear, as is assumed in most earlier studies. This paper re-examines the relationship between financial development and CO2 emissions based on a panel data of 61 countries categorised as high- and middle-income economies, from 1990 to 2018. This study uses the linear ARDL and nonlinear ARDL (NARDL) methods to analyse the impact of positive and negative shocks in financial development on CO2 emissions. Additionally, the panel causality between the variables is also investigated. The analyses from ARDL and NARDL reveal that in the long run, financial development helps to minimise CO2 emissions for high income economies, but it raises CO2 emissions and thereby decreases environmental quality for middle-income economies. Supporting our nonlinear hypothesis, we find that both negative and positive shocks of financial development have significant impacts on CO2 emissions, while the latter have a more profound effect. In particular, the findings suggest that the impacts of financial development on CO2 emissions are distinctive in high- and middle-income economies, leading to useful policy implications, including the suggestion that international development bodies help middle-income countries to incorporate consideration of environmental effects into the operation of their financial institutions and systems at an earlier stage of development than would generally be the case.