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

A Markov switching DSGE model with financial frictions investigates the effects of unconventional monetary policy (UMP) exit strategies. Agents in the model have rational expectations about the probability of financial crises, the probability of a UMP response to crises, and the exit strategy used. Selling off assets quickly produces a doubledip recession; in contrast, a slow unwind generates a smooth recovery. Increasing the probability of a UMP response to crises lowers pre-crisis consumption. The welfare benefits of increasing the probability of UMP may differ ex-ante versus ex-post, as can the preferred exit strategy. ∗The views expressed herein are solely those of the author and do not necessarily reflect the views of the Federal Reserve Bank of Kansas City or the Federal Reserve System. I thank Juan Rubio-Ramirez, Francesco Bianchi, Craig Burnside, Nobuhiro Kiyotaki, Eric Swanson, Stephanie Schmitt-Grohe, and Giuseppe Ferrero for helpful comments, as well as seminar participants at Duke, the Federal Reserve Banks of Richmond, Kansas City, and San Francisco, the Federal Reserve Board, Boston College, Michigan State, McMaster, the Bank of Canada, the 2011 International Conference on Computing in Economics and Finance, the 2011 North American Summer Meetings of the Econometric Society, and the "Conference on Zero Bound on Interest Rates and New Directions in Monetary Policy." Any remaining errors are my own. †Research Department, Federal Reserve Bank of Kansas City, 1 Memorial Drive, Kansas City, MO 64198, www.econ.duke.edu/∼atf5/, [email protected]