The classical model of macroeconomics assumes wages and prices are completely flexible.

Inflation is the growth rate of the price of aggregate output.

With an inflation target, the central bank adjusts interest rates to try to keep inflation close to the target inflation rate.

Under inflation targeting, the ii schedule shows that at higher inflation rates the central bank will wish to have higher real interest rates.

The central bank sets the nominal interest r not the real interest rate i.

The macroeconomic demand schedule, MDS, shows how inflation affects aggregate demand when the interest rate is set in pursuit of an inflation target.

The aggregate supply schedule shows the output that firms wish to supply at each inflation rate.

At potential output all inputs are fully employed. It is long-run equilibrium output.

Money illusion exists if people confuse nominal and real variables.

In the classical model, the aggregate supply schedule is vertical at potential output. Equilibrium output is independent of inflation.

Monetary policy accommodates a permanent supply change by altering the real interest rate (shift in the ii schedule) to induce a similar change in aggregate demand.

In the classical model with a vertical AS schedule, a rise in government spending crowds out an equal amount of private spending. Aggregate demand remains equal to potential output.

In the classical model, faster nominal money growth is accompanied by higher inflation but leaves real output constant at potential output.

The short-run supply curve, SAS, shows how desired output varies with inflation, for a given inherited growth of nominal wages.

A permanent supply shock changes potential output. A temporary supply shock shifts the short-run aggregate supply schedule, but leaves potential output unaltered.

Monetary policy accommodates a temporary supply shock when monetary policy is altered to help stabilise output. The consequence, however, is higher inflation.

When all shocks are demand shocks, stabilising inflation also stabilises output, even in a Keynesian model.

Flexible inflation targeting commits a central bank to hit inflation targets in the medium run, but gives it some discretion about how quickly to hit its inflation target.