Is it really that bad to be irrational when it comes to economics?

Several years ago I heard a joke about two macroeconomists who went hunting with a non-economist colleague. As they tracked a deer up a slope and over the crest of a hill, they noticed it edged into a clearing, making a perfect silhouette on the horizon. Within heartbeats of each other the two economists fired. One missed by ten feet to the right and the other missed by ten feet to the left. The deer ran off immediately, unharmed and the two men yelled in joy and began to high five and slap each other on the back. Their colleague asked how they could be so excited when they had both missed by a substantial margin. They replied. "Yes, we missed. But on average we hit him right between the eyes!"

Modern macroeconomic thinking incorporates the concept of rational expectations. Rational expectations is the notion that while individuals in the economy may not always be able to accurately predict the future, they at least do not consistently underestimate or overestimate. On average people hit their forecast targets right on.

To continue with the hunting analogy, suppose you have a gun with a bad sight. When you fire it into a target you consistently hit it too low and to the right. If you could not adjust the sight and were forced to take the gun hunting, you would mentally adjust by aiming a bit high and to the left of the intended target, in an attempt to correct the bias. Households and firms do something similar when they forecast the future of the economy. Household savings decisions, for example, are based on expectations about what interest rates will be earned in the future and what wages the household can expect in future years. Often households rely on analysis from professional financial planners and/or economy-watchers, but they make the same kinds of adjustments.

Rational expectations as an economic theory says that agents in the economy will take all relevant information into account when forming a forecast or expectation of the future. Failure to do so leads to mistakes that the agents will regret later. Just as failure to adjust for the bad sight on a gun leads failure in hunting, failure to adequately process all relevant information leads to bad economic outcomes. Incorporating this insight into economic models has led to a vast improvement in the quality of macroeconomic models over the past several decades.