Allan Meltzer, a renowned historian of the Fed, warned in an op-ed last week: “Never in history has a country that financed big budget deficits with large amounts of central bank money avoided inflation. Yet the U.S. has been printing money -- and in a reckless fashion -- for years.”

Mr. Meltzer notes that the Fed relies on the Phillips Curve model, which posits an inverse correlation between inflation and unemployment. When there is too much (too little) slack in the labor market, wage inflation, which is the main driver of price inflation, tends to fall (rise). He states that the relationship has been unreliable and warns: “The Fed's forecasts of inflation ignore Milton Friedman's dictum that 'inflation is always and everywhere' a result of excessive money growth relative to the growth of real output.” Maybe so. However, even Mr. Friedman's model is a “slack” model because monetary growth is excessive -- and inflationary -- when it exceeds the potential growth of the economy and resource utilization is high.

The slack models of both Keynesian and monetarist macroeconomists ignore microeconomic factors, particularly the structure of markets. A competitive economy is likely to “produce” more output and less inflation for a given amount of monetary and fiscal stimulus than an uncompetitive one, which will be prone to produce less output and more inflation. I'm of the opinion that our economy is more competitive and less prone to inflation, as I've discussed previously. Technological innovations are boosting productivity and keeping a lid on labor costs.

We will see how this plays out in coming months now that April's unemployment rate was down to 6.3%, the lowest since September 2008. The short-term unemployment rate at 4.1% shows even less slack. Both of these jobless rates have been inversely correlated with wage inflation in the past. In recent months, wage inflation has risen slightly, but remains low.

Source: Ed Yardeni — Ed Yardeni is the president and chief investment strategist of Yardeni Research Inc., a provider of independent investment strategy and economics research for institutional investors.