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

Summary We 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.