Sustainability of Public Debt in Germany – Historical Considerations and Time Series Evidence

Abstract

SummaryWe analyse German public finances against a theoretical background using a unique database, retrieved from multiple sources covering the period between 1850 and 2010.Multiple currency crises and force majeure offer anecdotal evidence contradicting the historical perception of Germany being the poster child of European public finance. Given these corresponding breaks in time series, the empirical analysis is conducted for the sub-periods 1872-1913 and 1950- 2010. In addition to anecdotal historical analysis, we conduct formal tests on fiscal sustainability, including tests on stationarity and cointegration and the estimation of Vector Autoregression (VAR) and Vector Error Correction Models (VECM). While we cannot reject the hypothesis that fiscal policy was sustainable in the period before the First World War, the tests allow for a rejection of the hypothesis of fiscal sustainability for the period from 1950 to 2010. This evidence leads to the conclusion that Germany’s public debt is in dire need of consolidation. Albeit constituting a much needed reform to this development, the incompleteness of the German debt brake and fiscal federalism will have to be addressed in the coming years, in order to ensure that fiscal consolidation actually takes place - for the sake of public debt sustainability.

Macroeconomic imbalances, financial stress and fiscal vulnerability in the euro area before the debt crises: A market view

“…C5 suggests that this country experienced many fiscal stress episodes from 1999 until 2006. This conforms with the conclusions of previous studies on the historical analysis of German public finances (see, among others, Burret et al, 2013;Palazuelos-Martinez, 2008). The deficit-GDP ratio was −1.5% in 1999, turning to a positive surplus of 1.3% in 2000, and then regularly evolved above the limit allowed by the Stability and Growth Pact.…”

Fiscal Transfers and Fiscal Sustainability

“…See, for example, Hamilton and Flavin (), Trehan and Walsh (, ), Wilcox (), Quintos (), Ahmed and Rogers (), Fincke and Greiner (), Koester and Priesmeier (), Byrne, Fiess, and MacDonald (), Prohl and Westerlund (), and Burret, Feld, and Köhler (). On theoretical considerations of public debt sustainability, see Bohn (, , ).…”

Fiscal institutions in Germany

“…During WWI and WWII incurring higher debt for war finance was particularly feasible since the Reichsbank monetized public finances. Following the wars a reduction of debt was accomplished by a combination of defaults, inflation and currency reforms instead of consolidation (Burret, Feld and Köhler, 2013). (II) In the long peacetime period following the Second World War, public borrowing was not less of an issue.…”

“…It has meanwhile arrived at levels that are unsustainable in the long-run (Burret, Feld and Köhler, 2013). In Section 2 of this paper, we illustrate this situation of public finances in Germany.…”