The question asks what is the effect of targeted and supposedly purposeful public expenditure on GDP. This involves looking at public expenditure that is not automatic and thus excludes the effect of unemployment benefits. The fiscal multiplier explains how many €cents are created in an economy as the result of €1 spent by a government.
This study, from the CEPR, proposes a number of ideas. Standing between the studies of Barro (1991) and Barro (2009) and those of Romer (2009), which seem to contradict each other, it argues that the effects of fiscal multipliers are best undestood in light of the environment in which they take place. Thus it focuses on whether the relevant economies are opened or closed, have fixed or flexible interest rates, are emerging or developed, more or less indebted and whether the focus of the fiscal stimulus is investment or consumption.
Multipliers are stronger in closed and developed economies, under fixed exchange rates and if they focus on public investment rather than on public consumption.
Additionally, this article also suggests (page 0, abstract point (2) ) that there is no difference between tax decreases and expenditure increases, which to economic neoliberals distraught would imply that the government has at least as good information about the needs of individuals as these individuals do themselves. It would imply that there is no asymmetry of information between tax payers and their government. This may have to do with the fact that in OECD countries (the sample used) countries do tend to use counter cyclical fiscal policy. This means that government spends money when it becomes the most scarce, ie during economic downturns. In this sense it is easy to understand why it makes no difference to have the government or individuals spend the money. Effectively, the government spends the money purchasing public projects from private companies, which in turn pay their workers, which in turn put their money in the bank who latter loans it to private sector companies, which will use it to efficiently compete in the market (excluding market inefficiencies, which may not be the smartest thing given that during economic downturns, if they are caused by decreases in investment, they will invariably involve the bursting of a bubble which means that at least for a while it is likely that the market will be a bit inefficient as it will be unable to distinguish between good and bad investments). Its basically, keynesian policy. Obviously this should end quite rapidly as soon as the market finds its balance again, as otherwise public expenditure will crowd out private investment.
My only question is really about this issue of cyclicality. I may have missed it, but I don't find any distinction between pro-cyclical effects and counter cyclical effects of the fiscal multiplier... As I said above the answer seems pretty obvious that counter cyclical policy ought to have more of an effect than pro-cyclical policy, but it would be nice to see evidence (a control variable for lagged economic growth or for official recessions).
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