In effect, it compensates for the period of economic weakness induced by both the zero lower bound and the unusual persistence and severity of the headwinds now buffeting the economy by holding the federal funds rate lower for longer than the modified Taylor rule, thereby maintaining greater accommodation as the economic recovery takes hold.
But this is not the full story. Positive demand shocks – related to the strong pick-up in demand following the relaxation of COVID-19 restrictions – have also been at play. To me, two main types of evidence point to an important role that demand shocks have played so far. First, for some time now, inflationary pressures have been increasingly broad-based.