peter praet : recent economic developments in the euro area remarks by mr peter praet, member of the executive board of the european central bank, at the febelfin working group of bank economists, brussels, 16 november 2017. * * * the ecb has introduced several monetary policy measures since june 2014, which have played a crucial role in supporting the economy and have been demonstratively effective in preventing a period of disinflation from slipping into one of outright deflation. more than three years later, the risks of deflation have mostly disappeared due to the effective transmission of our policy measures to the real economy, which is clearly evidenced by a broad - based cyclical recovery with solid momentum. this lays the groundwork for a return of inflation to below, but close to, 2 % over the medium term. overall, inflation developments, despite the solid growth, remain subdued. convergence of inflation towards our aim therefore remains conditional on a substantial degree of monetary policy accommodation. before focusing more on price dynamics and monetary policy, let me make some observations about the latest economic developments. real gdp in the euro area has expanded for 18 consecutive quarters, growing by 2. 5 % year on year during the third quarter of 2017, according to eurostat – a rate that exceeded our projection at the start of the year. this compares with the latest potential growth estimates for the euro area of just over 1. 4 %. 1 the latest survey data point to a strong fourth quarter. the composite output purchasing managers ’ index – which has a high correlation with growth in the euro area – remains above its long - term average and is close to six - year highs. overall, survey data continue to point to growth in the quarters ahead. moreover, eurostat ’ s economic sentiment indicator is near a ten - year high. the ongoing recovery has led to solid employment gains. the number of people employed in the euro area has increased by almost 7 million since hitting a trough in mid - 2013. this means that all of the employment losses recorded during the crisis have been offset. additionally, the unemployment rate is now at its lowest level in eight years and continues to decline, notwithstanding an increase in labour force participation. employment growth, together with the gradual increase in employee compensation, supports households ’ disposable income and is underpinning solid consumption dynamics. robust consumer spending is driven by buoyant sentiment, favourable bank lending conditions and the notable progress achieved with respect to deleveraging. the investment

cent over the medium term. inflation and the " output gap " our inflation - targeting system also helps to smooth the peaks and valleys of the business cycle and to avoid the boom - and - bust pattern seen in earlier decades. we do this by acting in a symmetrical manner ; that is, we pay equal attention to any significant movement in inflation away from the 2 per cent target, whether above or below. the crucial task in controlling inflation is to judge how the economy is performing relative to its economic potential. economic potential is a very important concept, so i want to take a minute to describe it. potential output, or production capacity, is the amount of goods and services that can be produced without putting pressure – in either direction – on inflation. when the economy is producing less than its potential, economists say there is an output gap. that gap tends to put downward pressure on inflation, so the bank will ease monetary policy to stimulate growth. we do this by lowering our target for the overnight interest rate. when the economy is operating above its potential, excess demand builds. this puts upward pressure on inflation, and the bank will tighten monetary policy to try to cool the economy, bring it back down to its level of production potential, and return inflation to the target. keep in mind that changes in our policy rate work their way through the economy slowly. it takes up to two years for a change in interest rates to have its full impact on demand, output, and ultimately, on prices and inflation. so we have to be forward - looking in our interest rate decisions. at our fixed announcement dates, we are not trying to affect today's inflation. what we are aiming at is future inflation and acting pre - emptively to achieve a balance in supply and demand going forward. this may sound easy in theory, but the reality is complicated. for one thing, it is impossible to measure the economy's potential with precision. all economists can do is to make their best estimate – a highly educated estimate, i might add, but an estimate nonetheless – of the level of economic activity that represents full capacity. and since one cannot measure potential with precision, it is impossible to measure the exact size of the output gap or the amount of excess demand. so the bank looks at a wide variety of indicators to assess how much pressure there is on capacity. we monitor statistics canada reports on how closely factories are operating relative to their capacity. we survey businesses across the country to see where firms are feeling production