Nonlinearity in Energy Demand Dynamics in Iran using a Smooth Transition Error-Correction Model (STECM)

Abstract

Growing energy consumption in Iran has raised concerns for future energy exports’ capacity. Effective policies should be identified for consumers’ responses. Since the possibility of nonlinearity in the dynamics of energy demand in existing literature is confirmed, and a linear estimation can be led to specification bias and wrong policies, this paper uses a new nonlinear model, Smooth Transition Error Correction Model (STECM), to examine the energy demand dynamics in Iran. The results of this study indicate that the error-correction term can have the role of the appropriate transition variable in this nonlinear error correction model. Based on the estimated model, two extreme regimes have been identified in the dynamics of energy demand in Iran. In the regime, with a high deviation from long-run equilibrium, the price and income elasticity of demand and the speed of adjustment are higher. But in the other regime which is related to near long-run equilibrium, the consumer’s incentive for reaction is less and so, the elasticities and the adjustment rate were small. The price elasticity of demand in both regimes is less than one, and therefore energy in Iran is inelastic. So, policymakers need to use non-price policies to manage energy demand.