The effectiveness of fiscal and monetary policy has been found to exhibit large heterogeneity across countries, and it hinges heavily on households’ marginal propensity to consume (MPC) in response to the policy shocks. This paper examines the role of households’ liquidity, saving, and credit constraints as microfactors that underpin households’ MPC and hence affect the macro level fiscal and monetary policy effectiveness.

This paper presents a uniform framework to measure the degree of various constraints faced by consumers, and employs data from 20 European countries to examine their nexus with hand-to-mouth (HtM) households. Our findings demonstrate that (i) a higher ratio of HtM households generally enhances fiscal multipliers; in particular, the size of tax multipliers is enhanced by the wealthy-HtM ratio (HtM households that hold positive illiquid wealth), whereas the size of fiscal spending multipliers is enhanced by the poor-HtM ratio (households that hold no illiquid wealth); (ii) monetary efficacy is higher in countries with larger HtM ratios, especially those with higher wealthy-HtM ratios; (iii) sole liquidity-constrained HtM households (type-I HtM households) enhance the efficacy of fiscal and monetary policies, but triple constrained HtM households (type-II HtM households that are liquidity-, saving-, and credit-constrained) do not enhance the efficacy, or even do the opposite. The triple constrained case is true especially for the monetary efficacy due to the dampening effect of the credit constraint. This paper contributes to the literature by providing evidence for the heterogeneous impacts of liquidity vs. saving and credit constrained HtM households, and wealthy- vs. poor-HtM households on fiscal and monetary efficacy.