Final answer:
Quantitative easing (QE) is utilized by central banks to stimulate economic activity when traditional monetary controls like short-term interest rates are ineffective. It involves purchasing long-term government bonds to lower long-term interest rates, which in turn is intended to spur aggregate demand.
Step-by-step explanation:
Quantitative easing (QE) is a monetary policy instrument used by central banks to stimulate the economy when traditional monetary policy tools become ineffective. QE involves the purchase of long-term government and private mortgage-backed securities to increase the money supply and make credit more available, with the aim of spurring aggregate demand. When short-term interest rates are at or near zero, lowering them further to stimulate the economy is not possible; this scenario prompted the Fed, under Chairman Bernanke in 2008, to turn to QE as a means to lower long-term interest rates instead.
The process of QE typically leads to a rise in the prices of long-term government bonds and a drop in their yields, which translates to lower long-term borrowing costs for consumers and businesses. By doing so, the central bank hopes to encourage spending and investment, which can help to boost economic activity. At the same time, an increase in the money supply can also devalue the currency, potentially leading to increased exports due to more competitive pricing.