Classical dichotomy
In
absolute rather than the relative prices
between goods.
The classical dichotomy was integral to the thinking of some pre-Keynesian economists ("
new classical theories of macroeconomics. In new classical macroeconomics there is a short-run Phillips curve which can shift vertically according to the rational expectations being reviewed continuously. In the strict sense, money is not neutral in the short-run, that is, classical dichotomy does not hold, since agents tend to respond to changes in prices and in the quantity of money through changing their supply decisions. However, money should be neutral in the long run, and the classical dichotomy should be restored in the long-run, since there was no relationship between prices and real macroeconomic performance at the data level. This view has serious economic policy consequences. In the long-run, owing to the dichotomy, money is not assumed to be an effective instrument in controlling macroeconomic performance, while in the short-run there is a trade-off between prices and output (or unemployment), but, owing to rational expectations, government cannot exploit it in order to build a systematic countercyclical economic policy.[1]
Post-Keynesians reject the classic dichotomy as well, for different reasons, emphasizing the role of banks in creating money, as in monetary circuit theory
.
References
- ISBN 978-3-319-17578-2.
Further reading
- Roy Green (1987). "Classical theory of money," The New Palgrave: A Dictionary of Economics, v. 1, p. 449.
- Don Patinkin, (1987). "Neutrality of money," The New Palgrave: A Dictionary of Economics, v. 3, pp. 639–644.
- Huw Dixon, Of Coconuts, decomposition and a Jackass: the genealogy of the Natural Rate, Surfing Economics, Chapter 3.