5 - The classical system and the neutrality of money

Abstract

This chapter presents the main features of the classical system and the role played within it by monetary variables. The classical system cannot be attributed to the work of any one particular economist. It is in fact a synthetic summary of the various ideas and propositions formulated by a large group of economists from the middle of the 18th century to the 1930s. Money matters if variations in the money stock exert a systematic effect upon macrovariables that economists feel are important for some reason or another. There are two categories of macrovariables, real and monetary; the former comprises variables such as the level of output, employment, real wages, and real rates of interest, while examples of the latter are money wages, prices, and nominal interest rates. Some economists feel that the criterion by which money is viewed to be of importance is whether it is capable of influencing the real equilibrium profile of the economy or not. They argue that if variations in the money stock have no effect on the real system, then money is neutral and money does not matter. Other economists would argue that both monetary and real variables are of importance to policy-makers who have the responsibility of controlling the behavior of both, for example, high and stable levels of employment and reasonable price stability. On this interpretation, money could be said to matter if its behavior is capable of influencing either real or monetary variables or both.