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Noah Smith

Why Economists Have Trouble With Bubbles

The dominant theory says people and markets can't be wrong.
Child's play, except for economists.

Child's play, except for economists.

Photographer: Dina Rudick/Boston Globe/Getty Images

One of the strongest orthodoxies in modern economics is being challenged, and there could be big implications for the state of the profession. The new, rebellious ideas might also help us understand why financial bubbles happen. 

Economists have realized for a very long time that expectations are crucial to economic behavior. If you expect to lose your job, you might consider holding off on buying a car. If you expect inflation in the future, you might consider buying things now, before prices go up. And so on. The problem is that it's very tricky to make mathematical models that capture how people set their expectations. Do they form them from long-term trends? Do they look at recent changes? Do they make predictions based on theories, and if so, what theories do they use?