Studying models of financial markets in which agents are too smart for asset bubbles to ever occur is a worthy, and even at times noble, endeavor. But when it comes to real-world policy decisions, economists need to bring to bear everything we know about the world, even things that we have had a tough time analyzing in formal economic models. And we need to keep in mind especially those facts about the world that remind us of our own ignorance. When I took a first-year macro class in graduate school from Larry Summers, Larry had a practice of presenting a model and then promptly proceeding to tear it down. I went up after class to complain that this was very discouraging. Larry Summers said something I have never forgotten: “It isn’t easy to understand how the world works.” Larry Summer’s maxim
It isn’t easy to understand how the world works
is an excellent mantra for an economist to repeat to himself or herself several times before giving policy advice.