...six in ten Americans think most of the money spent to rescue banks will be lost forever. Six in ten think the economy shrunk over the past year. One in two think federal income taxes have gone up in the past two years.
Wrong. Wrong. And wrong.In theory, it would still be possible for rich, sophisticated arbitrageurs to bet against the public in all these areas, and thus bring the overall path of markets back in line with the predictions of any given model. But most of the wealth of the economy is (directly or indirectly) under the control of the people who have these wrong impressions; so I think it unlikely that rational expectations can effectively operate. Especially since the errors are not random, but systematic; Derek Thompson in the article above has five explanations for why this might be.
David Laibson gave a fascinating talk on this topic at the Geary Institute on Tuesday; he introduced the concept of natural expectations, which combine two different ways of predicting the future: first, an intuitive extrapolation of current trends; second, a rational expectations component which matches the real data. Laibson's forthcoming paper (with Andreas Fuster and Brock Mendel) explaining this model is here.