Brad DeLong — Why Did Keynes Write "In the Long Run We Are All Dead"?

History of economics lesson.

Keynes is discussing how to use the quantity theory of money as an analytical tool.

What he is saying is that you cannot assume that you can analyze the consequences of an altered time path of the quantity of cash in the economy--n, in Keynes's notation--without considering whether the public's demand for real cash balances k, the public's demand for real checking-account balances k', and banks' desired reserves-to-deposits ratio r will also change. This is a principle that today's economists call the "Lucas Critique". (No, it is not clear to me why they do not call it the "Keynes Critique".) And this critique is correct: assume that those three other variables are not themselves altered when you consider an altered path for the money stock is, as Keynes says in the sentence after "in the long run…", for economists to set themselves too easy a task--it sweeps all the problems of analysis under the rug--and too useless a task--it generates predictions that are simply wrong.

In this extended discussion of how to use the quantity theory of money, the sentence "In the long run we are all dead" performs an important rhetorical role. It wakes up the reader, and gets him or her to reset an attention that may well be flagging. But it has nothing to do with attitudes toward the future, or with rates of time discount, or with a heedless pursuit of present pleasure.

So why do people think it does?

Note that we are speaking not just of Ferguson here, but of Mankiw and Hayek and Schumpeter and Himmelfarb and Peter Drucker and McCraw and even Heilbronner--along with many others.….

Grasping Reality with the Invisible Hand
Why Did Keynes Write "In the Long Run We Are All Dead"?
Brad DeLong | Professor of Economics, UCAL Berkeley

Brad DeLong — Why Did Keynes Write "In the Long Run We Are All Dead"?

The definitive explanation and its misrepresentation.

It's Keynes statement of what later came to be called "the Lucas Critique."

Grasping Reality
One Last April-Fools Note on Niall Ferguson: Why Did Keynes Write "In the Long Run We Are All Dead"?
Brad DeLong | Professor of Economics, UCAL Berkeley

UPDATE:

Peter Dorman comments

Econospeak
How Long Before You Have to Order a Refill for the Keynes Day Planner?
Peter Dorman | Professor of Political Economy, The Evergreen State College

Jason Smith — "Economics is a social science"

Economists (and everyone else out there in the econoblogosphere): time to stop hiding behind theory and qualitative analysis and start addressing the empirical data out there.

Theory versus Big Data? Maybe not.

Economic theory plays an important role in the analysis of large data sets with complex structure. It can be difficult to organize and study this type of data (or even to decide which variables to construct) without a simplifying conceptual framework, which is where economic models become useful. Better data also allow for sharper tests of existing models and tests of theories that had previously been difficult to assess.

Cameron K. Murray — Micro-foundations don't escape Lucas Critique

The fundamental flaw in conventional economic (econometric) modeling is the assumption of regularity that is supposedly supplied by microfoundations. "Microfoundations" assumes rationality and it is rationality that gives individual behavior regularity across individuals. It is the basis from assuming a representative agent as the totality of agents, disregarding supposedly irrelevant differences. Since all agents act rationally, it can be assumed, for example, that they are utility maximizers, and operate regularly irrespective of policy change and institutional difference.

This assumption is contradicted by empirical research in social science. The relationships of elements of a system, in this case individuals, are as important or more important than the individuals themselves in determining system outcomes. Murray cites a report of recent research by Joseph Henrich, Steven J. Heine and Ara Norenzayan of the University of British Columbia, The Weirdest People in the World, that calls into question the suitability of economists making assumptions based on personal introspection about rationality or even relying on psychological research on a limited population. "

As the three continued their work, they noticed something else that was remarkable: again and again one group of people appeared to be particularly unusual when compared to other populations—with perceptions, behaviors, and motivations that were almost always sliding down one end of the human bell curve.

In the end they titled their paper “The Weirdest People in the World?”(pdf) By “weird” they meant both unusual and Western, Educated, Industrialized, Rich, and Democratic. It is not just our Western habits and cultural preferences that are different from the rest of the world, it appears. The very way we think about ourselves and others—and even the way we perceive reality—makes us distinct from other humans on the planet, not to mention from the vast majority of our ancestors. Among Westerners, the data showed that Americans were often the most unusual, leading the researchers to conclude that “American participants are exceptional even within the unusual population of Westerners—outliers among outliers.”

Given the data, they concluded that social scientists could not possibly have picked a worse population from which to draw broad generalizations. Researchers had been doing the equivalent of studying penguins while believing that they were learning insights applicable to all birds.

 Fresh economic thinking
Micro-foundations don't escape Lucas Critique
Cameron K. Murra

Also, as Rumplestatskin, The basic flaw in all economic modelling

The question then becomes, is conventional economics descriptive or performative? Is neoliberalism assumed in the assumptions as a norm?

 

Noah Smith — The most damning critique of DSGE

If DSGE models work, why don't people use them to get rich?

When I studied macroeconomics in grad school, I was told something along these lines:

"DSGE models are useful for policy advice because they (hopefully) pass the Lucas Critique. If all you want to do is forecast the economy, you don't need to pass the Lucas Critique, so you don't need a DSGE model."

This is usually what I hear academic macroeconomists say when asked to explain the fact that essentially no one in the private sector uses DSGE models. Private-sector people can't set economic policy, the argument goes, so they don't need Lucas Critique-robust models.
The problem is, this argument is wrong. If you have a model that both A) satisfies the Lucas Critique and B) is a decent model of the economy, you can make huge amounts of money. This is because although any old spreadsheet can be used to make unconditional forecasts of the economy, you need Lucas-robust models to make good policy-conditional forecasts….

So now let's get to the point of this post. As far as I'm aware, private-sector firms don't hire anyone to make DSGE models, implement DSGE models, or even scan the DSGE literature. There are a lot of firms that make macro bets in the finance industry - investment banks, macro hedge funds, bond funds. To my knowledge, none of these firms spends one thin dime on DSGE. I've called and emailed everyone I could think of who knows what financial-industry macroeconomists do, and they're all unanimous - they've never heard of anyone in finance using a DSGE model….

But if finance-industry people can't know which DSGE model to use, how can policymakers or policy advisors? 

In other words, DSGE models (not just "Freshwater" models, I mean the whole kit & caboodle) have failed a key test of usefulness. Their main selling point - satisfying the Lucas critique - should make them very valuable to industry. But industry shuns them.
Many economic technologies pass the industry test. Companies pay people lots of money to useauction theory. Companies pay people lots of money to use vector autoregressions. Companies pay people lots of money to use matching models. But companies do not, as far as I can tell, pay people lots of money to use DSGE to predict the effects of government policy. Maybe this will change someday, but it's been 32 years, and no one's touching these things.

As I see it, this is currently the most damning critique of the whole DSGE paradigm.

Noahpinion
The most damning critique of DSGE
Noah Smith | Assistant Professor of Finance } Stony Brook University

Peter Radford — The Lucas Mystique

Peter Radford trashes the Lucas critique as magical thinking. Nice job.

Real-World Economics Review Blog

The Lucas Mystique
Peter Radford

John Aziz — Minsky, the Lucas Critique, & the Great Moderation

Looks at Ben Bernanke, Scott Sumner, and J. M. Keynes as well. If you read this, don't overlook the link to Brad DeLong's debunking of misconceptions about Keynes's assert that in the long run we are all dead.

Azizonomics

Minsky, the Lucas Critique, & the Great Moderation

John Aziz

Andrew Lainton schools Noah Smith on math and SFC

Without a proper modelling of state DGSE is simply mathematically flawed, and to dismiss mathematically correct approaches as ‘physics envy’ displays a basic error of understanding what is necessary to correctly model ANY dynamic system using the fundamental principles of applied mathematics.  Noah needs to get some Maths Envy.

If we correctly model state then we need correct modelling of all factor incomes and investments in future income streams that will yield factor incomes.  Only then will the model be both microeconomically and macroeconomically consistent.  But you have to do both together, at the same time, and only then will you be able to avoid the lucas critique.  The approach that macroeconomics must be microfounded is the wrong way to approach this, it makes the most basic error in all of the social sciences, trying to collapse structure into agency.

Decisions, Decisions, Decisions
@Noahopinion @Profstevekeen The Problem is ‘Maths Envy’ Not ‘Physics Envy’ in Supplanting DGSE
Andrew Lainton | Consultant (UK)

Woj — Network Models Can Restore Emergence in Economics

Is the economics profession using outdated models that don't handle complexity when such models are available and in use in other fields?

Read it at Bubbles and Busts
Network Models Can Restore Emergence in Economics
Woj