Does government spending actually help during a recession, or does it just add debt?
Background
Fiscal policy is the most direct way a government can influence aggregate demand, but its effectiveness is one of the most debated topics in macroeconomics. The same policy can produce a multiplier above 2 in one context and below 0.5 in another.
The state of the economy matters enormously. At the zero lower bound with spare capacity, fiscal stimulus faces less crowding out. In a fully-employed economy with active monetary tightening, the same stimulus may produce mostly inflation.
What it covers
Fiscal policy encompasses government spending on goods and services, transfer payments, taxation, and the borrowing that fills the gap between revenues and outlays. In a recession, expansionary fiscal policy (higher spending or lower taxes) can fill the demand hole left by retreating private spending.
The size of the fiscal multiplier -- how much GDP rises per dollar of fiscal stimulus -- depends on the state of the economy, the monetary policy response, the type of spending, and whether households are liquidity-constrained. Estimates range from below 1 (if crowding out or Ricardian equivalence dominates) to above 2 (at the zero lower bound with broad-based spending).
Open question
Given the current state of the economy, monetary policy, and debt levels, will additional fiscal spending generate a large multiplier or be offset by crowding out, inflation, or anticipatory household saving?