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Long Run Money Part 3 Classical Dichotomy and Money Neutrality - YouTube
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- In this video segment,
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I'm going to talk
about something
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that we've been dancing around
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and that's the issue of what we
call the classical dichotomy.
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So a dichotomy is when things
are split into two opposing
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or totally separate categories,
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you know, good and evil,
black and white,
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so on and so forth.
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And the classical dichotomy says
that all economic variables are
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either nominal or real.
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And nominal variables
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are expressed in currency units.
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So for instance your nominal
wage might be $10 an hour.
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And nominal is a word
that basically comes back
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to the idea of name
like nombre in Spanish.
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Real variables are not
expressed in currency units,
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or they're expressed
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in inflation adjusted units.
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So one way of looking at this is
if your wage is $10 an hour,
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and a gallon of milk costs $4,
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then what's your wage
in terms of gallons of milk?
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Your wage we could say
is 2.5 gallons of milk per hour.
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And notice here that when we
take two nominal variables
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and construct a ratio
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of them the dollar signs kind
of cancel out,
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and we get a real variable.
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So typically the ratio
of two nominal variables
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is a real variable.
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And that might sound sort
of hopelessly arcane or sort
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of why the heck does this matter
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because when we
put things in a ratio,
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we're putting them in a context.
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If I tell you
that your wage is $10 an hour,
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that actually doesn't
tell you that much.
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$10 an hour right
now you might sort
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of struggle to support a family,
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but $10 an hour 20
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or 40 years ago would
have been a really good wage.
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So the idea here is that
by putting things in this ratio,
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we compare them to something
else and we put them in context.
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So ratios put things in context.
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So that's why I say for instance
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also we look at things
like GDP per capita,
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the ratio
between a country's GDP
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and its total population
because then
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we have some information
about the context.
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How much does that real
GDP actually mean?
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So this classical
dichotomy is something
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that we're going to go ahead
and look at.
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When we think
about what's called
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money neutrality.
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So money neutrality is the idea
that in the long run
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changes in the money supply
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don't affect real variables
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and essentially
the idea is something like this.
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Let's suppose we think
about our country's total GDP.
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And a country's total
GDP depends upon, you know,
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what its natural
resources are and how big
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its labor force is
and how talented they are,
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and how much capital they have.
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And how much what the level
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of technology is and so on
and so forth.
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If we go ahead and say double
the money supply,
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or let's say even
multiply it by 10.
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So we all pull all the currency
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out of our pockets
and just add a zero to it,
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and all the banks add a zero
to all of our bank accounts
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but also to all of our debts,
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then what's going to happen?
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Well, essentially we've just
scaled everything up by a factor
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of 10 and probably what would
mainly happen is that businesses
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would scale up their prices
by a factor of 10 as well.
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And it wouldn't really
change much in the economy.
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So that's the basic
argument here,
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that in the long
run production is constrained
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by the supply of the factors
of production,
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land, labor, capital,
etcetera.
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And if we go ahead
and print lots of money,
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we can't summon up,
you know,
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more factories just
by printing money.
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We can't, you know,
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make land more fertile just
by printing more money.
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We can't instantly give people
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an education
by printing more money.
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We might be able to sort
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of engage
in some government spending,
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using the money but that's sort
of a different question,
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that's a question of
what happens when you change
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government spending and use it
to make some investment.
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So the money supply change
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itself we think does not
have real long run effects.
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