In words explain Classical Dichotomy, Money Neutrality, and the Classical theory (short and long run).

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Answer - .

Introduction :

Together , Neutrality of money is a short run concept to the long run Classical Dichotomy , which says that money circulation effects just the prices and not the level of real output in the economy

Classical Dichotomy or Classical Theory of money:

It is believed to be happen when real variable i.e. output and real rate of interest are being studied without analysing the money value of output and interest which means MONEY IS CONSIDERED NEUTRAL .

It further takes pre Keynes approach to believe that money is veil in LONG RUN -

Using the phillips short run curve ,along with it analysing the rational expectations which bring in curve ; however this Neutrality of money fails here as in SHORT RUN MONEY IS NOT NEUTRAL . But in long run it is believed to be neutral thereafter can't help to control macro economic performance
But in short run , with the trade off between price and output cause of rational expectations state also can't make proper policy to control it
This was criticised by Keyens and Monetarist ,as they believed that prices are sticky in; where former rejected prices fails to adjust due to supply and demand and latter believed due to banks role to create money .

Neutrality of money :

It was given by Friedrich A.Hayek in 1931.Neutrali money theory is related to classical dichotomy ,wherein it believes that central bank does not affect the economy in real terms by creating money

Which means that variantion in money supply though effects wages ,goods and services but cannot effect economic productivity
It's assumption towards money neutrality in long run ,holds in all macroeconomic theory
It is believed by many to be applicable in long run
But the modern believers of same theory say that money supply might affect output and unemployment during the short run

Conclusion :

Both talk about different possibilities that come with the change in money supply however and have different outcomes; for the former it is of long run and for latter it is for short run

Kindly please rate the answer and do feel free to ask in case of doubts

Rahul Sunny answered 1 year ago

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