Why fiscal stimulus packages don't work

Here is further proof why those large fiscal deficits only serve to weaken economic growth.

Since August 2007, the US economy has experienced two fiscal stimulus packages. The first was under Bush in April 2008; the second was under Obama in January 2009. The idea behind both packages was the same. Cut taxes and increase government spending in order to put money in consumer's pockets, who would then go out and buy stuff and sustain economic activity.

However, US consumers have other ideas. Instead of spending, they have decided to save. The US savings rate has jumped to almost 7 percent. Back in the bubble days, US household savings rate had fallen to almost zero.

The jump in savings is even more surprising given that US interest rates are close to zero. US Households must be very keen to save.

Both stimulus packages can be clearly identified in the US savings rate. The first peak is Bush. The recent upswing in savings, which starts in 2009, is due to Obama.

So why are US consumers suddenly saving? Everyone knows that the current deficit is unsustainable and therefore taxes will soon have to increase dramatically. The current increase in household incomes are temporary and they will soon fall when higher taxes kick in. Consumers are trying to stabilize their income over time and building up their assets in anticipation of the future federal clawback.

Economists call this Ricardian equivalence, but that is just a fancy name for a simple idea. Consumers instinctively know that a deficit must be paid back and that fiscal stimulus packages never work.

The irony is that we have known this since the days of David Ricardo, who first explained this principle. He lived during the 19th century. So why are we having to learn this lesson again?