Financial Crises, Unconventional Monetary Policy Exit Strategies, and Agents’ Expectations

A central bank may purchase assets during a financial crisis and then exit from those purchases. Agents have rational expectations about financial crises as rare events, the probability the central bank purchases assets, and the exit strategy. Selling off assets quickly produces a double-dip recession while slowly unwinding generates a smooth recovery. Expectations about the exit strategy influence the initial effectiveness of purchases. Increasing the probability of purchases during crises distorts the pre-crisis economy and depends upon the exit strategy. The welfare benefits of unconventional policy may differ ex-ante versus ex-post, as can the preferred exit strategy.