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Table 2 shows that the US federal government responds only weakly to aggregate public debt. Since
1994, fiscal policy has adjusted and is focused on consolidation, however. In contrast to the weak debt
response of the federal government, consolidation in the US states is much stronger. Only 3 out of 50
states do not contribute to the stabilisation of the aggregate debt burden. We strongly reject that the
sum of regional stabilisation coefficients is smaller than the stabilisation effort of the federal
government. Hence, not only is US fiscal policy sustainable, there are apparently no soft budget
constraints. States do not shift the burden of consolidation to the federal government, or to other states.
Actually, government tiers in the US fiscal system face even harder budget constraints. We test fiscal
rules separately for the federal government and the panel of US regions. The federal government’s
stabilising response to federal debt is strong and significant (Table 3). The stabilising response to debt
remains if we control for a cyclical reaction of the federal budget.20 At the same time, the reaction of
state fiscal surpluses to debt is equally strong to their respective state debts. Hence, we would argue
that fiscal responsibilities in the US fiscal system are clearly set out such that the federal and state
governments consolidate their own debt. In other words, debt is sustainable in the US because federal
fiscal policy responds to federal debt, and given the transfers received from other government tiers,
states are able to consolidate their own debt too.21
In contrast, the German fiscal system faces some more problems. Fiscal relations are less well
managed by the federal government and the Lander. The joint reaction of both government tiers to
aggregate debt indicates widespread fiscal problems (Table 4). The federal government does not react
in a significant way to public debt developments, and half of the Lander do neither. The debt response
of the regional governments is not obviously stronger than that of the federal government. Hence,
fiscal policy is unsustainable but it is not clear that the federal government assumes fiscal problems of
the Lander, and solves their debt situation. Fiscal problems have not started with Reunification, nor
owe these to large deficits in the new Lander. The fiscal system ran into trouble for the former West-
German Lander already. If anything, the problems of unsustainability of German public finances were
even more widespread before Reunification. The federal government was running down surpluses in
the wake of increasing debt. Only two Lander would contribute to aggregate debt stabilisation before
1991. After Reunificaiton, the majority of old Lander does so. In contrast, only two out of six Lander
run unsustainable policies.
As the aggregate debt burden may hide a shift of liabilities from one government tier to the other, we
test the fiscal rule for the federal government alone (Table 5). This shows the lack of a significant
20 In contrast to Wibbels and Rodden (2006), we find that the cyclicality of regional budgets is rather low.
Cyclical variations are non-existent (or even procyclical) in the German Lander budgets.
21 The estimation of a fiscal rule for every state individually confirms positive debt responses (results not
reported).
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