Beyond renewables: The role of financial systems,green innovation,and energy efficiency in mitigating emissions in small advanced economies

Abstract

Climate change mitigation in small, resource-intensive economies remains a significant policy challenge, especially where financial systems, technological innovation, and energy transitions are not fully aligned. This study addresses this gap by investigating the dynamic interrelationships between financial development (FD), renewable energy consumption (REC), environmental-related technologies (ERTs), and energy efficiency (measured through coal and gas efficiency) in shaping greenhouse gas (GHG) emissions in Iceland a country with near-total renewable electricity generation but persistent sectoral emissions. Using a triangulated econometric approach including Kernel-Based Regularized Least Squares, Fully Modified Ordinary Least Squares, Dynamic Ordinary Least Squares, and frequency domain Granger causality analysis the study captures both non-linear interactions and short- vs long-term causal dynamics. Results reveal that while REC has a statistically significant negative effect on GHG emissions, the environmental effectiveness of FD and ERT depends on the regulatory environment and sectoral application. Notably, the frequency domain analysis shows that REC and ERT exert stronger long-term causal effects on emission reduction, while FD's impact is more pronounced in the short run and context-dependent. This research contributes to the literature by integrating financial, technological, and energy efficiency dimensions within a unified empirical framework tailored to the institutional characteristics of small economies. The findings suggest that decarbonization policies must go beyond energy supply transformation to include financial mobilization strategies, sector-specific regulatory incentives, and sustained investment in enabling infrastructure such as smart grids and storage. For policymakers, the results underscore the importance of aligning green finance mechanisms with targeted technological deployment to ensure comprehensive and equitable emissions reduction.