Electricity is a good that has transversal impacts on all economic sectors, thus affecting the economic cycle of countries and regions. Temperatures also directly and indirectly impact the economic cycle, directly affecting productivity and indirectly impacting electricity consumption via increased thermal fluctuations. Regarding this last relationship, works such as Franco and Sanstad (2008), Fung, Lam, Hung, Pang, and Lee (2006), and Wouter Botzen, Nees, and Estrada (2021) have observed non-linear relationships between electricity consumption and temperature, all describing an asymmetric U-shaped relationship between electricity and temperature.
Notably, studies of the relationship between electricity and economic development have associated higher levels of electricity consumption with higher levels of economic development. The findings of Yoo and Kwak (2010) and Wolde-Rufael (2006) indicate that although the extent of this link varies between countries, the essential relationship remains.
Yoo and Kwak (2010) investigate this relationship in seven South American countries (Argentina, Brazil, Chile, Colombia, Ecuador, Peru, and Venezuela) for the period 1975–2006. The authors perform Granger causality tests and detect short-term unidirectional causality between electricity consumption and real GDP for Argentina, Brazil, Chile, Colombia, and Ecuador. However, in Venezuela, there is bidirectional causality between electricity consumption and economic growth, potentially representing a feedback effect between the two variables.
Gómez and Rodríguez (2015) investigate the Mexican case for the period 1971–2011. The results show a causal relationship between economic growth and energy consumption, proving the conservation hypothesis –it assumes that causality runs from economic growth to electricity consumption (Payne, 2010; Alkhars, Miah, Qudrat-Ullah and Kayal, 2020). This importantly indicates that energy policies have little or no impact on national economic growth. Gámez and Rodríguez (2023) conclude that there have been significant setbacks in terms of energy sustainability in Mexico in the last 20 years.
Although Wolde-Rufael (2006), Yoo and Kwak (2010), and Karanfil and Li (2015) use different country groups and periods, they agree that the electricity consumption–economic growth nexus depends deeply on regional particularities and levels of economic growth. Wolden-Rufael (2006) refers to levels of electrification, Yoo and Kwak (2010) to industrial structures, and Karanfil and Li (2015) to income levels, urbanisation, and the level of electricity dependence. This enables the conclusion that richer economies represent lower levels of causality and a shorter-term relationship between growth and electricity consumption. Meanwhile, in poorer economies, there is typically a long-term high level of causality.
Substantial evidence for the relationship between electricity consumption and economic growth prevails in some countries, including Pakistan and Nigeria. In the case of Pakistan, the analysis of electricity demand by Sarwar and Hanif (2018) estimates a significant and positive relationship in the short and long term, aligning with the findings of Ali, Gong, Wu, and Rizwanullah (2020). In Nigeria, electricity consumption has been observed to have a positive effect on economic growth in both the short and long term (Sani and Abdullahi, 2019). However, despite various observations of the strong correlation between electricity consumption and economic growth, there remain few studies concerning the causal effects (Burke, Stern, and Bruns, 2018).
Regarding the direct effects of temperature on the economic cycle, Dell, Jones, and Olken (2012), Kalkuhl and Wenz (2020), and Kotz, Wenz, Stechemesser, Kalkuhl, and Levermann (2021) agree that temperature has a more intense negative effect on poorer countries. Although each of these studies analysed different regions and periods, this conclusion persists. However, Dell, et al. (2012) and Kotz et al. (2021) extend observations with regard the effect on economic growth from an increase of a 1°C temperature, whereas Dell, et al. (2012) estimate a reduction of 1.4% in economic growth, in Kotz et al. (2021) the reduction is assessed in 5%. Although the authors do not use the same variable, it can be observed that the magnitude of the impacts of temperature on economic systems is important because these impacts are comparable to the average size of the effect of GDP volatility on national growth rates (Kotz et al., 2021). Elsewhere, Burke, Hsiang, and Miguel (2015) show that overall economic productivity is non-linear in relation to temperature, with productivity peaking at an annual average temperature of around 13°C and strongly declining at higher temperatures. This means that geographic regions that have cold climates are usually more productive. Choi (2023) demonstrates that increases in temperature volatility in the US are related to climate change reflected in temperature data.
Regarding the increasingly important influence of temperature on electricity consumption, Sailor (1997) and Staffell and Pfenninger (2018) similarly conclude that temperature variability has been increasing over time, increasingly impacting electricity consumption. Staffell and Pfenninger (2018) associate the concept of climate variability with risk, which is essential for establishing practical use of the knowledge obtained in terms of informed decision-making on energy planning and policy. Several studies analysing the relationship between development, electricity, and temperature––such as those by Boukhelkhal and Bengana (2018), Mukherjee and Nateghi (2019), and Hor, Watson and Majithia (2005)––have concluded that temperature is the weather factor that most impacts electricity consumption. They have also determined strong correlations between growth in electricity consumption and GDP and between increased electricity demand and population. In a dynamic climate context, ensuring a reliable supply of electricity is essential: Having a robust energy system enables countries to provide strength and security on the path to economic development.
In an analysis of 198 countries over 36 years, Wesselbaum (2021) finds that for each 1°C increase in temperature, GDP per capita reduces by about 3% over ten years, providing evidence about the effects of temperature on economic development. Temperature effects in the same direction have been reported by Zahra, Sabir, and Imtiaz (2022) for the South Asian Association for Regional Cooperation and Association of Southeast Asian Nations countries. However, global warming affects the former group more than the latter.
Real business cycle theory assumes that changes in the technology create random fluctuations altering the levels of supply and consumption and, consequently, the state of equilibrium of the economies (Kydland and Prescott, 1982; Long and Plosser, 1983). These fluctuations are produced from many sorts of disturbances, among them are the shocks macroeconomic generating recessions and booms, that is, the economic cycles (Mankiw, 1989). Real business cycle models take the first steps needed to assess and understand the economic equilibrium, same that can be observed in its temporal evolution and its correlation with external shocks and its own behaviour over time. The business cycle is understood as a movement between individual economic variables divided into four phases: expansion, recession, depression, and recovery. The basic approach has attempted to understand how aggregate economic variables behave in response to shocks external, such as changes in technology, preferences, and government policies (Greenwood, Hercowitz and Huffman, 1988). However, real business cycle theory can also be understood analysing the movements in no-economic variables but very related, as electricity consumption and the variability in temperature. Temperature experiences a more homogeneous path in time than economic development, but it can be a shock transmission mechanism for the business cycle since it influences the electricity consumption. Therefore, temperature should be an important factor of cyclical disturbance, mainly in the last years of rapid global warming, according to the IPCC (2019) report.
Using the business cycle theory enables the analysis of fluctuations and co-movements of variables over time to identify short- and long-term trends (Agenor, McDermott, and Prasad, 2000). Knowledge of the economic cycle and its relationship with electricity consumption and temperature cycles allows for the adequate design and generation of public policy concerning energy and economic development.