Affiliations: London Borough of Camden, Town Hall, Judd Street, London WC1H 9JE, London, England
Abstract: The paper studies the causal and long-run relationship between petroleum imports and economic growth in Cyprus for the period 1960–2004 using a newly developed ARDL (autoregressive distributive lag) approach to cointegration, which is according to Pesaran, Shin, and Smith (2001). To supplement the findings of cointegration, the causal relationship was assessed using Granger causality test. Additionally, the strength of causality was tested using the innovation accounting or variance decomposition analysis, which is according to Pesaran and Shin (1998). The study finds a stable long-run cointegrating relationship with a long run bidirectional causality running interactively through the error correction term. This suggests that Cyprus is an energy dependent island where negative shocks to energy, such as shocks leading to higher energy prices or energy conservation policies, will impact on the island’s economy negatively. The policy implication is that reducing petroleum imports can lead to a fall in income and any conservation measures adopted should take into consideration the negative impact they have on economic growth. Cyprus should also find ways of diversifying its sources of petroleum imports in order to reduce supply uncertainties and dependence on a single source of energy.