explain our assessment in greater detail, starting with the economic analysis. following the 0. 3 % quarter - on - quarter increase in euro area real gdp in the fourth quarter of 2010, recent statistical releases and survey - based indicators point towards a continued positive underlying momentum of economic activity in the euro area in early 2011. looking ahead, euro area exports should be supported by the ongoing recovery in the world economy. at the same time, taking into account the relatively high level of business confidence in the euro area, private sector domestic demand should increasingly contribute to economic growth, benefiting from the accommodative monetary policy stance and the measures adopted to improve the functioning of the financial system. however, the recovery in activity is expected to be dampened somewhat by the process of balance sheet adjustment in various sectors. in the governing council ’ s assessment, the risks to this economic outlook remain broadly balanced in an environment of elevated uncertainty. on the one hand, global trade may continue to grow more rapidly than expected, thereby supporting euro area exports. moreover, continued strong business confidence could provide more support to domestic bis central bankers ’ speeches economic activity in the euro area than currently expected. on the other hand, downside risks relate to the ongoing tensions in some segments of the financial markets that may potentially spill over to the euro area real economy. downside risks also relate to further increases in energy prices, in particular in view of ongoing geopolitical tensions, and to protectionist pressures and the possibility of a disorderly correction of global imbalances. finally, there are potential risks stemming from the economic impact on the euro area and elsewhere of the recent natural and nuclear disaster in japan. with regard to price developments, euro area annual hicp inflation was 2. 6 % in march 2011, according to eurostat ’ s flash estimate, after 2. 4 % in february. the increase in inflation rates in early 2011 largely reflects higher commodity prices. pressure stemming from the sharp increases in energy and food prices is also discernible in the earlier stages of the production process. it is of paramount importance that the rise in hicp inflation does not lead to second - round effects in price and wage - setting behaviour and thereby give rise to broad - based inflationary pressures over the medium term. inflation expectations must remain firmly anchored in line with the governing council ’ s aim of maintaining inflation rates below, but close to, 2 % over the medium term. risks to the medium - term outlook for price developments remain on the

, up to a point, an equilibrium response of the economy to certain shocks, which does not necessarily warrant a policy reaction. two types of shocks that could be associated to such a development, could be, first, the permanent effect on the cost of financing and capital stemming from entering a new regime of low inflation and, second, the real convergence expected to happen in catching - up countries. in benign scenarios, the apparent imbalances are largely self - correcting. eventually, the inter - temporal budget constraints will induce consumers and firms to cut their expenditures, thereby reducing the current account imbalances. these adjustments will be accompanied by movements in relative prices, as the economies concerned rebalance domestic and external demand. the fact that some episodes of current account deficits and rising relative prices could be natural economic adjustments to shocks that hit the economy does not, of course, imply that all such episodes are benign, equilibrium phenomena. looking at developments in a number of euro area countries over the past 11 years, we have enough evidence of private sector imbalances that cannot be explained by reference to benign equilibrium phenomena. how could such imbalances come about? i think there are three plausible ( and not necessarily mutually exclusive ) explanations : first, expectations about growth seem to have become detached from reality and have indeed become excessively exuberant. if we are willing to depart from the assumption of strictly rational expectations and to allow for phenomenon such as learning, it is easy to see how initial booms – justified by equilibrium phenomena – induce economic agents to expect that the strong growth will continue indefinitely ( or at least for a longer period than was warranted ). in this regard, it is worth noting that most of the bubbles we have observed in history started in response to changes in fundamentals. a second factor is the behaviour of the financial system. at the global level, the period was one in which financial intermediaries around the world were engaging in excessive risk - taking behaviour. this led to bad credit risk management and very loose credit conditions, which added fuel to the fire in the case of overheating economies. third, the standard adjustment mechanisms implied by theory seem not to have worked sufficiently well or sufficiently fast. in particular, the real appreciation channel seems to have been operating very slowly, and inflated animal spirits seems to have put in question the existence of the fully rational inter - temporal optimisers taken as given in many models. in addition, the public sector itself may also have been