Dynamic Interactions Between Public Finances and Economic Activity in Germany

How do German public finances respond to economic developments? And what is the impact of large economic shocks on fiscal sustainability? Vice versa, what is the effect of sustainability restrictions on fiscal stimulus measures? In the context of the ongoing sovereign debt crisis, these questions constitute the core of public finance debates. Based on advanced macro-econometric methods, this study offers new insights to this field. The author shows how expenditure dynamics have been decisive for ruining the sustainability of public finances in Germany and how a debt brake could bring them back on a sustainable path. He demonstrates how static estimation methods fail to detect dynamic relationships between tax bases and tax revenues – especially with respect to profit taxes. Finally, he shows that economic stimuli programmes in Germany have become gradually more pro-cyclical over the last four decades and sustainability restrictions have strong effects on the size of fiscal multipliers.