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QE: When and How Should the Fed Exit?

The essence of Quantitative Easing (QE) is to reduce the costs of private borrowing through large-scale purchases of privately issue debts, instead of public debts (Ben Bernanke, 2009). Notwithstanding the effectiveness of this highly unconventional monetary policy in reviving private investment and the economy, it is time to think about the likely impacts of the unwinding of QE (or the reversed private-asset purchases) on the economy. In a standard economic model, if monetary injections can increase aggregate output and employment, then the reversed action will likely undo such effects. Would this imply that the U.S. economy will dive into a recession once the Fed starts its large-scale asset sales (under the assumption that QE has successfully pulled the economy out of the Great Recession)? This paper shows that three aspects of the Federal Reserve’s exit strategy matter for achieving (or maintaining) maximum gains in aggregate output and employment under QE (if any): (i) the timing of exit, (ii) the pace of exit, and (iii) the private sector’s expectations of when and how the Fed will exit.

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