Fiscal Policy Rules in Practice

Temporal Distribution of Regime1

Temporal Distribution of Regime2

Figure 1: Germany, Fiscal Policy Rule, Temporal Distribution of Regime Probabilities, 1970-

2003.

between revenues/GDP and debt/GDP. These may easily be plotted using the estimated median
values of the coefficients for γ_B (S_t^F = 1), γ_B (S_t^F = 2) and the two constants. This delivers a
straight line in debt/output, revenue/output space for each of the two regimes. A graphical
representation is given in figure 3 and will be discussed in detail in section 2.4. In regime 1 we
observe larger values for the revenue/GDP ratio than in regime 2, when the debt/GDP ratio
exceeds a value of about 140 %. When looking at the data for Germany’s debt/output ratio, we
find values of almost 250 % toward the end of the sample⁸ . From this it follows that regime 1
leads to larger revenue/output ratios in comparison to regime 2 at the end of the sample, when
fiscal authorities have accumulated a substantial level of debt.

This shows that there seems to be a tendency toward a more sustainable fiscal policy in
Germany with respect to debt in the late 1990s. Nonetheless, this shift in fiscal policy behavior
is not permanent, as we observe fluctuations between the two regimes till the end of the sample
period in figure 1. The analysis suggests so far that German fiscal policy underwent changes
in its fundamentals, as the switch to regime 1 means a decrease in autonomous government
expenditures, as depicted by the constant, combined with a more reactive behavior to increases
in government debt.

⁸ One should note that we divide total debt by quarterly GDP. Therefore, the debt/output ratio on an annual

basis would be four times smaller.

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