It is difficult to get solid evidence on the economy's response to changes in government spending. Direct reporting measures—such as those employed by Recovery.gov, the U.S. government's website for tracking stimulus spending—capture the direct and observable effects of government spending on economic activity. These measures can be helpful, but they fail to account for the indirect, less-easily observable effects of government spending. To capture the big-picture effect of government spending, economists turn to the spending multiplier.
The multiplier effect or spending multiplier refers to the idea that an initial amount of government spending leads to a change in the activity of the larger economy. In other words, an initial change in the total demand for goods and services (what economists term aggregate demand) causes a change in total output for the economy that is a multiple of the initial change. For example, if the government spends one dollar and, as a result of this spending, the economy (as expressed by the Gross Domestic Product, or GDP) grows by $2, the spending multiplier is 2. If the economy grows by $1.50, the spending multiplier is 1.5. However, if the economy only grows by 50 cents (a loss from the original $1 spent), the spending multiplier is 0.5.
