Classical economics was a school of thought stating that markets regulate themselves and will return to equilibrium without government interference. The Great Depression challenged this view. Although prices fell, demand did not increase because so many people lacked jobs and money. John Maynard Keynes introduced a theory, called Keynesian economics, which emphasized the role of government in the economy. Keynes said the Depression continued because neither consumers nor businesses had an incentive to increase spending. Companies would not increase production if consumers had no money to buy their products. Consumers who were unemployed had no money to spend. Keynes argued that the government could buy more goods and services, encouraging production, which in turn would put more people back to work.

     Fiscal policy is powerful because of the multiplier effect, the idea that every dollar change in fiscal policy creates a greater than one dollar change in the national economy. For example, if the government buys $10 billion in goods and services, GDP increases by more than $10 billion because firms spend money on wages, raw materials, and investment. Workers, suppliers, and stockholders will have money to spend.

     Supply-side economics states that taxes have a negative effect on economic output. Supply-siders argue that lower taxes put more money in people’s pockets, which in turn leads to greater investment and more jobs. Under President Ronald Reagan in the 1980s, the government cut taxes and implemented supplyside policies.