Yesterday I made the argument that the Fed may want to hold off on raising interest rates because every month we are getting more evidence that the unemployment rate below which inflationary pressures are sparked is lower than consensus estimates.

My AEI colleague John H. Makin gives an additional reason: That the Fed is too complacent about the possibility of deflation:

The Fed is in an awkward position, as was clear from Janet Yellen’s tough slog through her December 17 press conference. The Fed’s main message – that monetary tightening (interest rate boosts) will probably start in June of this year – squares well with strong growth and falling unemployment but is bizarre given falling inflation and the additional deflationary impulse (from falling energy and commodity prices and a stronger dollar). The Fed has decided simply to assert that US deflation won’t materialize, so it will continue on its current path toward mid-year tightening. This is a dangerous course to follow, especially in view of rising global deflation pressure.
Deflation is dangerous for three reasons: (1) it makes people and firms do things that create more deflation; (2) it boosts real, inflation-adjusted interest rates which in turn deters investment and slows growth; and (3) it boosts trade tensions by forcing countries – like Japan, China, and Europe – that are trying to reflate in a world of weak domestic demand to allow their currencies to weaken, thereby exporting deflation to countries like the US that are exhibiting some modest growth of domestic demand.

Read his entire argument here.

— Michael R. Strain is deputy director of economic policy studies and resident scholar at the American Enterprise Institute. You can follow him on Twitter at twitter.com/MichaelRStrain.