after falling to 7 percent in the third quarter of 2001, rebounded to 12 percent in the first quarter of 2004, a pace of advance not experienced since 1983. half of this rise in the profit share occurred between the first quarter of 2003 and the first quarter of 2004, a period during which business costs were unusually subdued. in fact, consolidated unit costs for the nonfinancial corporate business sector actually declined during this period. the increase in output per hour in the nonfinancial corporate business sector of more than 6 percent accounted for much of the net decline in unit costs. the remainder was due to the effects of rising output in reducing nonlabor fixed costs per unit of output. hence, at least from an accounting perspective, between the first quarter of 2003 and the first quarter of 2004, all of the 1. 1 percent increase in the prices of final goods and services produced in the nonfinancial corporate sector can be attributed to a rise in profit margins rather than rising cost pressures. however, businesses are limited in the degree to which they can raise margins by raising prices. an increase in margins should affect mainly the level of prices associated with any given level of unit costs but, by itself, should not prompt a sustained pickup in the rate of inflation going forward. in a market economy, any tendency for profit margins to continue to rise is countered largely by the entry of new competitors willing to undercut prices and by increased labor costs as more firms attempt to exploit the opportunity for outsized profits by expanding employment and output. that increase in competitive pressure, as history has amply demonstrated, with time, returns markups to more normal levels. over the past three decades, the share of the profits of nonfinancial corporations in the total nominal income of that sector has fluctuated around a longer - run average of roughly 10 - 1 / 2 percent. the profit share in the first quarter of this year, at about 12 percent, was well above that level. the gap suggested that the growth of unit profits would eventually slow relative to increases in unit costs. this outlook had accorded with analysts ’ expectations for earnings growth over the next year, which are substantially below the realized growth of profits in recent quarters. indeed, some leveling or downward pressure on profit margins may already be in train, owing to a pickup in unit labor costs. although advances in productivity are continuing at a rate above the longterm average, they have slowed from the extraordinary pace of last summer and are

the euro area and secure price stability. during this period, paradoxically, the greatest danger that the governing council had to confront was not the one that the founders of the single currency had feared. the ecb is institutionally hard - wired to combat inflation. this was the key preoccupation of the architects of the euro, born out of the german experiences with hyperinflation, both during the inter - war years and in the aftermath of the second world war. from this preoccupation stem essential features of the set - up of the single currency area : a fiercely independent central bank, with a clear mandate to pursue price stability and robust safeguards to stop the ecb from monetising budget deficits, historically the root of runaway inflation. during the financial crisis, however, the nature of the problem the ecb faced was entirely the opposite. time and again, the ecb had to act to prevent an unduly sharp fall in economic activity and head off the risk of deflation. deflation, which is a widespread and ongoing fall in prices, may lead consumers to postpone spending and firms to slash investment. both factors lead to a reduction in aggregate demand, lower output, higher unemployment and further downward pressure on prices. this is arguably as dangerous a situation as spiralling inflation. in late 2008, the ecb faced a situation in which firms, households and governments were carrying excessive debt, at the same time as the banks had to reduce their own leverage. with the collapse of lehman brothers, the immediate problem was a shortage of liquidity and the breakdown of the money market. this threatened the health of the euro area economy as a whole, with declining output, rising unemployment and weaker inflationary pressures. in response, between october 2008 and may 2009, the governing council lowered key interest rates by 275 basis points, bringing the rate on the main refinancing operations down to 1. 0 %. many of these measures were taken in concert with the major central banks around the world. under normal economic conditions, such a reduction in short - term interest rates is quickly transmitted to bank lending and deposit rates. in turn, lower interest rates encourage households and firms to consume and invest more, supporting aggregate demand directly. moreover, lower interest rates on euro - denominated assets lead to a depreciation of the exchange rate of the euro, stimulating exports. this smooth transmission of the impulses from monetary policy to the real economy depends critically on the health