Former Federal Reserve Chairman Alan Greenspan was hauled before a Congressional Committee last year to explain why he had been blindsided by the global financial cataclysm. To his credit, he didn’t duck the question, although his reply was a hall-of-fame understatement. It seems, he said with welling eyes, that there had been “a flaw” in his model of the financial economy.

Indeed. For twenty years, Green­span was the most important financial regulator in the world—the “Maestro,” who time and again steered the global economy through one tricky financial shoal after another, only to discover that his great boom was built on quicksand. It was a fake, a fraud—at its ugliest, a crass device for shifting huge amounts of income from working people to the very rich.

Greenspan was speaking truth, however, when he pointed to his “model” as the source of the disaster. John Maynard Keynes would have agreed. It was Keynes who famously pointed out that “the world is ruled by little else” than “the ideas of economists and political philosophers, both when they are right and when they are wrong.” Robert Skidelsky is a British historian, also trained as an economist, who has devoted much of the past thirty years to producing a magisterial three-volume account of Keynes’s life and thought. He published an abridged, single-volume edition of this study in 2003. His new book, Keynes: The Return of the Master, is an exploration of the financial crisis through Keynes’s eyes. Skidelsky knows the interior of Keynes’s mind as well as anyone in the world, and his book is a profound and beautifully written meditation on the dangers of bad ideas, readily accessible to anyone who isn’t mystified by the headlines in the Wall Street Journal or the Economist.

Keynes was right, Skidelsky assures us: ideas do matter, and the ideas that have ruled the economic and commercial world over the past quarter-century have been deeply wrong. They are a throwback to the ruling concepts of “classical” nineteenth-century economics—but reincarnated in a purer, more rigorous, more insistent form, rather like the Taliban’s hypermilitarized reimagination of classical Islam.

The ruling “Chicago School” version of economics, which Greenspan adopted as his own, is built on a few central dogmas: that free markets always set correct prices based on all available information; that demand and supply always balance—unemployment is theoretically impossible—and that the market’s judgment of risk is always the correct one. These ideas have been axiomatic for most economists since Adam Smith, but in the classical period they were understood almost as Platonic forms, dimly visible on the cave wall. A free-market ideal was useful in ridiculing parliamentary regulatory bodies that were pits of corruption and favoritism, spawning black markets, supply failures, and real hardship. “Let markets set prices!” was a liberal rallying cry.

These general principles quietly morphed into inflexible laws when economics departments were taken over by mathematicians in the 1950s and ’60s. Mathematical economists need the kind of simple hypotheses that Chicago School economics supplied. Without clean transaction rules, the complexity becomes unmanageable, making it impossible to build the kind of big-ticket model that, say, the Congressional Budget Office uses to assess the cost of health-care reform. But it’s not just the Chicago School. The difference between them and modern “neoclassical” Keynesians like Paul Krugman is infinitesimal, Skidelsky stresses. They build the same kind of models with many of the same assumptions; the Keynesians just assume rockier adjustment periods, which leaves an opening for targeted government interventions to nudge things back on track.

Skidelsky dismisses the modern pseudo-scientific construction of economics as an “illegitimate offspring of Newtonian physics” that could not be more different from the actual thought of Keynes. Keynes insisted that economics was a “moral science...it deals with introspection and with values...it deals with motives, expectations, psychological uncertainties. One has to be constantly on guard against treating the material as constant and homogeneous.”

“Macroeconomists,” who build large-scale models of the economy, typically proceed by teasing out correlations from the recent past. When the Federal Reserve increases the money supply by x, spending usually rises by about y, so they build that into their models. Keynes thought that was ridiculous: “There is no reason at all why [such relationships] should not be different every year,” he said. “With a free hand to choose coefficients and time lags...one can always cook a formula to fit moderately well a limited range of past facts. But what does this prove?” While Keynes did not deny the value of mathematics in formulating economic propositions, he did not believe it could be assumed; it was up to the mathematizer to prove its usefulness. The danger was always “a false precision” that the data did not really support.

Keynes parted company with almost all modern economists in his treatment of risk and uncertainty. For Keynes, “risk” was an actuarial concept. An insurance company with a good cross-section of the population in its customer base can with fair accuracy compute the annual rate of policy payouts. But one cannot price “uncertainties”—such as “the price of copper and the rate of interest twenty years hence, or the obsolescence of invention.... We simply do not know.”

Economists, Keynes thought, should focus on the short term. That belief was the backdrop for his famous comment that “in the long run we are all dead.” He thought that society progressed by “irregular movements” that were essentially unpredictable. One imagines that Keynes would be firmly on the side of the skeptics in the global-warming debate; he would at least be opposed to spending money on projects designed to tweak global temperatures thirty years hence instead of programs that would bring clean water to poor African villages today. At a more prosaic level, if one checks the annual consensus forecasts of economic growth by leading economists for any given year, it is astonishing how often they are utterly wrong. Keynes would ask why we even listen to them.

What Keynes would have found most disheartening, perhaps, is how economic theory has been used to immiserate the lives of the bottom half of the population. Economists praise the “flexibility” of the American work force. But the price of that is dreadful insecurity for the working stiff—no tenure, no (or minimal) health care, no pension. From 2002 to 2007, about two-thirds of all income growth went to the top 1 percent of the population. Income distribution in the United States at the end of the 2007 boom was even more skewed than in the 1920s.

Skidelsky’s reform proposals mostly focus on theory. He would separate “macro” from “micro” economics. Microeconomics works on the kind of closely bounded questions, like capital allocations, in which mathematics is extremely useful. The new macro departments would de-emphasize the math and scrap the models in favor of deeper immersion in history, politics, and cultures—a return to the study of “political economy,” which reigned before the hubristic quest for physics-like certainty.

These would be useful changes, but they are not about to happen. The big trading banks are minting billions again, and Wall Street’s court jesters, like Cato and the American Enterprise Institute, are already peddling a revisionist story: There’s nothing wrong with economics; the banks were just innocent victims in a culture war; Rep. Barney Frank (D-Mass.) made them shovel housing benefits toward poor people, and nearly brought down the world in consequence.