In similar fashion, setting actual interest rates below equilibrium rates stimulates economic activity, whereas setting interest rates above equilibrium restrains activity. Over recent years, economic activity in the euro area has been below potential – in other words there has been a negative output gap – which has put downward pressure on inflation.
The classic textbook prescription is simple: loosen monetary policy to drive interest rates below equilibrium, stimulating output to bring it back to potential and generate inflationary pressures to achieve the inflation objective. In general terms, the ECB’s monetary policy since the crisis fits that textbook prescription. But the finer details also matter.