Question

How does an economy that experiences a contractionary real shock in autonomous consumption spending (increase in real savings) adjust to full-employment equilibrium under the classical model?  While an anticipated change in the money supply is assumed to be neutral, an increase in the money supply that is unanticipated is assumed to be expansionary. Carefully explain why unanticipated money supply changes have effects while anticipated changes are neutral in terms of affecting real variables in the classical model.

Answer 1

Money is neutral because nominal money supply has no effect on output and the interest rate in the medium run. The increase in the nominal money supply is entirely reflected in the proportional increase in the price level.
In the classical system, money is neutral in its effects on the economy. It plays no role in the determination of employment, income and output. ... Thus money is neutral. It is simply a 'veil' whose main function is to determine the general price level at which goods and services exchange.