During extreme financial crises, all of a sudden, the financial world that was once rife with profit opportunities for financial institutions (banks, for short) becomes exceedingly complex. Confusion and uncertainty follow, ravaging financial markets and triggering massive flight-to-quality...

Central banks (the Fed) and markets (the market) often disagree about the path of interest rates. We develop a model that explains this disagreement and study its implications for monetary policy and asset prices. We assume that the Fed and the market disagree about expected aggregate demand....