How might inflation, even if fully anticipated, prevent the classical

How might inflation, even if fully anticipated, prevent the classical dichotomy from holding, even in the long run?

What will be an ideal response?

ANSWER

The classical dichotomy asserts that output is determined solely by the aggregate production function and the quantities of factors available. Inflation is like a negative technology shock that lowers productivity. Shoe-leather and menu costs represent uses of resources that add nothing to aggregate output. Because price increases throughout the economy are spread out over time, it is rational to react to the temporary changes in relative prices, even if the changes are known to be temporary. This causes distortions in the allocation of resources, and temporary, rational distortions are distortions, nonetheless.