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

48 Pages Posted: 21 Jun 2016

Date Written: 2012

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 (1960-2007), 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.

Keywords: Fiscal sustainability, Wagner's law, Structural breaks, Cointegration, Vector error correction models

JEL Classification: H63, H19, H50, E62

Suggested Citation

Priesmeier, Christoph and Koester, Gerrit B., Does Wagner's Law Ruin the Sustainability of German Public Finances? (2012). Bundesbank Discussion Paper No. 08/2012, Available at SSRN: https://ssrn.com/abstract=2796866

Christoph Priesmeier (Contact Author)

Deutsche Bundesbank ( email )

Wilhelm-Epstein-Str. 14
Frankfurt/Main, 60431
Germany

Gerrit B. Koester

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

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