Does Wagner's Law Ruin the Sustainability of German Public Finances?

Abstract

Abstract:The empirical and theoretical literature on long-term relationships in public finance is dominated by two approaches: Fiscal sustainability and Wagner's law of an increasing state activity. In this paper, we argue that these two relationships should be analyzed simultaneously and not separately. We show how Wagner's law might influence fiscal sustainability and how the interaction of the two can be modelled using vector error correction models that include public expenditures, revenues and GDP. For Germany, we find strong evidence for Wagner's law throughout the whole period analyzed , while our results indicate sustainability of public finances only until 1973. We show that, for the period after 1973, it is the interaction of permanent expenditure increases and revenue reductions resulting from fiscal policy reactions to the oil crisis and Wagner's law that ruins the sustainability of public finances in Germany. Our findings underline the importance of the German debt brake for re-establishing sustainable public finances even under Wagner's law.

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 Sustainability of the German Laender Time Series Evidence

“…We allow for a maximum of four lags which corresponds to the VAR lag length criteria on each variable in any Land under consideration. Koester and Priesmeier (2013) show that a significant constant in the error correction term is associated with fiscal unsustainability because it implies a wedge between revenues and expenditures. This contributes to the increase of deficits, especially if the time range extends across multiple decades.…”

Assessing Fiscal-Policy Sustainability: On the Different States of the Debt-to-GDP Process

“…Finally, aside from Wagner's law, some of the leading hypotheses (such as trade openness) on determinants of public expenditure are analyzed by Shelton (2007). In general, there seem to be consistent factors throughout history that raise public-debt levels, (temporarily) violating fiscal sustainability (see Koester and Priesmeier, 2013). Table 2 summarizes the results of common diagnostic tests -based on the residuals of a simple autoregressive model fitted to the data.…”