Having seen the immediate and not so immediate policy responses to the financial crisis it is time to address a deeper and – potentially – more disturbing question. In November 2008 Her Majesty the Queen was visiting the London School of Economics and reportedly asked a question that has since become famous and very, very relevant: “How come you didn't see it coming?” Where obviously she was addressing professional economists and financial experts at that institution. This question has given rise to several answers. Some economists (Besley & Hennessy 2009) put together a written response to Her Majesty, explaining what had happened and why it was not seen coming. This can be summarized as everybody doing the right thing, but the crisis was a one-off shock or an unforeseen and unforeseeable event. Any such answer appears obviously to have the aim of absolving both the policymakers in charge at the time and the theoretical models on which policies were formulated.

Other people, including prominent economists who have been at the very centre of policymaking, have taken a very different view, by claiming there had been something wrong about the policies being pursued and also about the economic models that were used to justify those policies. A prime example is Buiter, at one stage a member of the monetary policy committee at the Bank of England, who has famously written a very scathing article (Buiter 2009) about the uselessness of a particular type of macro and how it had engendered a sense that a crisis could not happen in the way that instead it did. Another such example would be Krugman who has been a very vocal critic of some macro models and hence the policies predicated on those models being very wrong.

A third set of answers asked the question: can it be that by pursuing the policies typical of the great moderation, an environment that actually fostered financial instability was put in place that eventually erupted in the financial crisis? Otherwise put, could it be that there is a trade-off between inflation targeting and financial stability? It is this kind of argument to which this chapter is dedicated with the first example being an adaptation of a diagram developed by De Grauwe (2012: 201) in his textbook on the economics of monetary union.