In an open economy, monetary policy has important effects on aggregate demand and thus on prices and output. The traditional channel through which central bank policies get transmitted to the real economy is via changes in borrowing costs. For example, if the central bank raises interest rates, borrowing costs rise and consumers are less likely to buy things they would have otherwise bought, and businesses will be less inclined to invest in capital goods. This lower demand will lead to lower output and prices.
Another channel is the provision of liquidity to support financial stability. In the face of a crisis, the conventional wisdom is that it is better not to try to deflate asset price booms before they turn into busts for fear of triggering a recession; instead, the central bank should provide ample liquidity to keep markets functioning and sustain the flow of credit to households and firms. This was the approach taken by Alan Greenspan after the stock market crash of 1987 and by most central banks in the incipient financial crises of the 1990s and 2000s.
In addition to providing liquidity, central banks can also expand their balance sheets by purchasing assets. This strategy is called quantitative easing or QE and involves buying securities in the secondary market to increase the amount of money available. These purchases can be targeted at specific sectors of the economy to help stabilize them. They can also help support a recovery from a deep recession by helping finance public spending on infrastructure and jobs.