Household Indebtedness and the Effectiveness of Fiscal Policy

ABSTRACT This study investigates whether the level of household debt significantly influences the effectiveness of fiscal policy. Our analysis, which uses heterogeneous panel data from 24 OECD economies, shows that the output effects of fiscal policy are ineffective in economies with high debt levels. However, its positive effects are more pronounced in economies with low debt levels. Departing from previous studies that focus on tax policy or crisis episodes, we provide macro‐level evidence that household debt systematically weakens fiscal policy transmission through the consumption channel. Our findings indicate that households with high debt levels may be more cautious about their spending behaviour, even in the presence of fiscal stimuli, due to concerns about their debt burden and future financial obligations. The results reveal that the effect of household debt on consumer behaviour is predominantly driven by precautionary saving motives rather than liquidity constraints, aligning more closely with the “wealthy hand‐to‐mouth” framework than traditional models. Overall, our study suggests that the level of household debt influences the effectiveness of fiscal policy, specifically, its ability to stimulate or affect consumer spending.