The classical dichotomy is the principle that, in the long run, the “real” economy can be separated from prices, inflation, and money.
(Peter Dungan, Toronto PPG1002H and Mankiw et al. 2008)
The classical dichotomy is rooted in the understanding that in the long run, real output is determined by “real” inputs such as labour, capital, natural resources and TFP, but not money. This means that changes in the money supply determine changes in the price level over time, but not real output. However, it is important to remember that the classical dichotomy applies only in the long run. Almost all economists would agree that money and price can have very important real impacts on the economy in the shorter run.
Information for this concept organized by Ben Eisen based on lecture notes from Peter Dungan’s PPG 1003H and Mankiw, N. Gregory, Ronald Kneebone, Kenneth J. McKenzie and Nicholas Rowe. 2008. Principles of Macroeconomics, 4th Canadian ed. Toronto: Thomson Nelson.