September 2023 marks two important milestones in the history of economics - the 50th anniversary of the event that led to the rise of the "Chicago School of Economics" and the 15th anniversary of the one that precipitated its fall.

Half a century ago, the "Chicago Boys" embarked on an experiment in Augusto Pinochet's post-coup Chile that would become the dominant economic-policy framework of our time, introducing a raft of radical measures inspired by the ideas of Milton Friedman and the rest of the Chicago School.

These ideas - born of an absolute faith in markets and an equally absolute suspicion of government - went on to rule the economics discipline and, more importantly, economic policymaking for the next 35 years. Not until the collapse of Lehman Brothers in September 2008, soon followed by the global financial crisis, did the Chicago School's ascendancy end.

The question now, 15 years later, is whether this longstanding economic orthodoxy is gravely injured or whether its advocates are merely licking their wounds and biding their time. The answer will depend on whether we have developed a proper understanding of the factors that led to the 2008 crisis, and of the challenges that have plagued many economies ever since.

For Friedman, no other economic pathology was of greater concern than inflation, which he viewed as a kind of macroeconomic fever. The cure, reminiscent of traditional medical wisdom, was that it needed to be starved or bled, in this case by reducing the supply of money and letting the economy sweat out the sickness. By contrast, his arch-nemesis, John Maynard Keynes, worried more about the factors that caused an economy to perform below its potential. These cases were more like the proverbial cold, where the patient needs to be fed and served ample fluids, in this case through government spending.

Following the stagflation of the 1970s, which amounted to a crisis for Keynesianism, Friedman's prescription of disciplining government spending and freeing markets through deregulation and trade liberalization was carried out widely. It was implemented not only in Chile but also in the United States under President Ronald Reagan and the United Kingdom under Prime Minister Margaret Thatcher in the 1980s.

Moreover, the same policies were also introduced - some might say imposed - globally through the Washington Consensus: a package of free-market measures pushed on developing countries when they sought assistance from the International Monetary Fund; on post-Cold War Russia (through "shock therapy"); and on the UK and southern European countries during the post-2008 austerity years. In each case, Friedman's favored treatment - letting the economy sweat out its fever, rather than suppressing it with government assistance - was meticulously administered.

But what if many of the biggest problems confronting the global economy have been misdiagnosed? What if, as behavioral economics argues, they are more psychological than material?

While Friedman's account of self-equilibrating markets involved economic agents whose features were largely implicit, his Chicago School colleague Robert Lucas's rational-expectations model imputed concrete cognitive characteristics to those agents. And it is Lucas's approach that has dominated economic thought since the 1970s. Lucas's model makes explicit the idea that we are all constantly processing large volumes of information to maximize our own welfare for any given economic context.

Yet behavioral economics - incorporating more recent insights from psychology, particularly Daniel Kahneman and Amos Tversky's work on the mental shortcuts, heuristics, and biases that shape our thinking - has shown the "rational actor" to be a chimera. Similarly, Cass Sunstein and Richard Thaler's scholarship has established that people do not exhibit rationality in some abstract sense. Rather, we make decisions based on "bounded rationality" (limited information), "bounded willpower" (knowing better, but doing something anyway), and, as I have noted, bounded self-interest (showing concern for more than one's own material welfare).

Behavioral economists' more limited policy prescriptions have been grudgingly accepted in microeconomic theory, with everyone now recognizing that individuals' and firms' actions routinely deviate from economic rationality. However, as I have argued previously, macroeconomics has remained impervious to behavioral insights, dismissing the field's findings as quirky digressions from rationality that will ultimately offset each other and come out in the wash. Longstanding models that assume rational welfare-maximizing behavior thus remain fully entrenched.

Yet, with the rise of populist politics, departures from hard-nosed rationality in policymaking are becoming more frequent and more dramatic. As a result, there is increasing empirical evidence from around the world underscoring the fact that economic agents are more likely to resemble the excitable Trumpian "Joe the Plumber" than former German Chancellor Angela Merkel's proverbial "Swabian housewife," the frugal, hyper-rational poster girl for austerity.

Where does this leave the economic orthodoxy of the past 50 years? The prognosis is not good. With one foot already in the grave, the Chicago School's remaining exponents would do well to reckon with its gory Chilean origin story. If neoliberalism's core assumptions bear no resemblance to real-world outcomes, economists owe it to themselves - and above all to the public - to acknowledge its true nature.

From Project Syndicate