Macroeconomics

classical dichotomy.

It is the hallmark of classical macroeconomic theory. The

classical dichotomy is an important insight because it simplifies economic theo-

ry. In particular, it allows us to examine real variables, as we have done, while

ignoring nominal variables. The classical dichotomy arises because, in classical

economic theory, changes in the money supply do not influence real variables.

This irrelevance of money for real variables is called monetary neutrality. For

many purposes—in particular for studying long-run issues—monetary neutrali-

ty is approximately correct.

Yet monetary neutrality does not fully describe the world in which we live.

Beginning in Chapter 9, we discuss departures from the classical model and

monetary neutrality. These departures are crucial for understanding many

macroeconomic phenomena, such as short-run economic fluctuations.

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