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This article describes the contributions made by economic theory in understanding the financial crisis. The author contends that throughout history, economic problems were solved with theories that addressed the immediate problem, only to have new economic issues emerge afterward. Economic theory was targeted at maintaining monetary stability during the 1980s and 1990s, leaving insufficient theoretical analysis to address interests of financial stability, which is the economic problem the world is facing today. The author points to a new theoretical approach that balances the interests of previous economy theory with new and emerging challenges.

This paper compares the European Central Bank's (ECB) conduct of monetary policy (1999–2005) with that of the Bundesbank (after the German Unification: 1990–1998) in order to test the hypothesis of an ECB with 'Bundesbank's preferences' put forward in the theoretical literature (Alesina and Grilli, 1993; Fatum, 2006). Econometric tests and simulations based on monetary policy reaction functions show that the continuation of the former Bundesbank regime is supported by the data. Given this empirical evidence we discuss the lessons for future Monetary Unions stemming from the ECB experience.