The classical dichotomy explains the assumption that nominal variables are strongly impacted by the amount of money and that money is essentially useless for understanding the determinants of real variables.
What exactly is a classic dichotomy?
- The classical dichotomy in macroeconomics refers to the notion that real and nominal variables can be studied separately, which is credited to classical and pre-Keynesian economics.
- To be more specific, an economy exhibits the classical dichotomy if it is possible to fully examine real variables, such as output and real interest rates, without taking into account what is happening to their nominal counterparts, the money value of output, and the interest rate.
- This specifically means that it is possible to calculate real GDP and other real variables without having access to information about the size of the nominal money supply or the rate of inflation.
- If money is neutral and has no effect on real variables other than the price level, an economy displays the traditional dichotomy.
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