We document that the interest rate response to fiscal stimulus is lower in countries
with high inequality or high household debt. To interpret this evidence we develop
a model in which households take on debt to maintain a minimum consumption
threshold. Now debt-burdened, these households use additional income to deleverage.
In economies with more debt-burdened households, increases in government spending
tighten credit conditions less (relax credit conditions more), leading to smaller increases
(larger declines) in the interest rate. To validate our mechanism we confirm that the
pre-Global Financial Crisis consumption response to fiscal stimulus is lower in countries
with high inequality or household debt and in U.S. counties with high household
debt. An implication of our theoretical and empirical results is that the sign of the
debt-dependence of the effects of fiscal stimulus varies with credit conditions.