When and how to exit quantitative easing?

The essence of quantitative easing (QE) is reducing the cost of private borrowing through large-scale purchases of privately issued debt instead of public debt (Bernanke, 2009). Regardless of how effective this highly unconventional monetary policy may be in reviving private investment and the economy in general, it is time to consider how exiting from these private asset purchases will affect the economy. In a standard economic model, if monetary injections can increase aggregate output and employment, then the reverse action may undo such effects. But does this imply that the U.S. economy will dive into another 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 article studies the likely impact of QE and its exit strategy on the economy. In particular, it shows that three aspects of the Federal Reserve?s exit strategy are important in achieving (or maintaining) maximum gains (if any) in aggregate output and employment under QE: (i) the timing of the exit, (ii) the pace of the exit, and (iii) the private sector?s expectations of when and how the Fed will exit.