Economic models are only capable of explaining 60% of the inflation observed in Europe, according to an IMF analysis The speed of transmission of the rise in the cost of energy to the rest of prices is being three times higher than what is observed in the pastIt is difficult to explain how the Spanish economy, growing only a few tenths, is capable of continuing to create jobs”When you have eliminated the impossible, what remains, however improbable it may be, must be the truth”. We don’t know if economists have already begun to think in Sherlock Holmes mode, but they should: their models are not capable of explaining part of the behavior of inflation and why employment increases if we are heading towards a sharp slowdown. The analysis departments of the main institutions are busy trying to figure out how to correct the flaws in their models. They are of such a size that they cannot be sent to the bin of errors. Perhaps one of the most startling admissions of these, shall we say economic enigmas, came from the tower of the International Monetary Fund (IMF): of the inflation observed in Europe, about half of it is not clear where it comes from. We know that the price of gas and raw materials have a lot to do with it… “but the analysis finds that a considerable part of the recent rebound cannot be explained”, explains a recent IMF report on Europe. “Traditional inflation models can only explain, at best, 60% of the price increase we see.” The conventional forces that pushed prices up in the past are not alone. They are accompanied by others that are not clear or identified. If the situation was already complex, now we have to deal with the challenge of diagnosing what else drives inflation and how it operates. And it doesn’t seem to play in our favor. The fund predicts that the process of reducing inflation will be “surely slower than expected and plagued by uncertainty.” The two shocks that Europe has experienced so closely together (the pandemic and the war in Ukraine) have altered “the structural relationships that support inflation,” argues the IMF. The bottlenecks of raw materials and the rigidity of the labor market are two suspects that are targeted. The Speed of Inflation Logic would indicate, with Holmes’s permission, that there may be a connection between that part of inflation that cannot be explained with the astonishing speed with which it is spreading through the economy. This factor also has a few experts baffled. “The increase in the cost of gas and raw materials has been more intense and faster than in the past,” pointed out a report from the Bank of Spain (BdE) a few weeks ago. Faced with a rise in costs, especially energy, the response of the underlying CPI (which does not include fresh food or fuel) “is now three times higher,” according to the supervisor’s analysis. The latest data for this indicator: 6.2%. The bank has been forced to correct its CPI forecast for 2022 upwards up to five times. “We thought it was going to be transmitted as before and there we have failed,” he acknowledged a few weeks ago Ángel Gavilán, General Director of Economy and Statistics of the BdE. What happened? “Perhaps the very magnitude of the disturbance in costs has forced companies to transfer it quickly to prices because there was not so much breadth in their margins,” replied Gavilán. Another possibility is expectations: “If companies believe that it is a permanent shock, they will reflect it more quickly in the prices of their products,” pointed out Jorge Sicilia, Chief Economist at BBVA, a month ago. Whichever way you look at it, inflation is not exactly as we remembered it. It has been more than thirty years since we did not have such a high price level. This problem, once very relevant, practically disappeared from the equations in advanced countries. And now that it has to be reincorporated, many old hypotheses do not square with what we see. Economists without answers In addition to prices, another unsolved mystery is: how is it possible that the economy continues to create jobs when it is barely growing? It is a very present enigma in our country. It is enough to put two figures together to short-circuit. Third quarter growth: GDP: + 0.2%. Employment: + 2.6% “It seems to me that there is no explanation. It is an enigma”, replied the Minister of Social Security, José Luis Escrivá when asked this week. His response is surprising because he is the minister who knows the most about economic models and predictions. “I do not think that now the Spanish economy is suddenly a greater creator of employment because after a pandemic and a cyclical recovery. These processes are very slow. I don’t finish understanding it”, insisted Escrivá in a meeting organized by the APIE. The reduction of the shadow economy could explain “a little bit” of the job creation data that we see. “But I find it hard to think that it is of sufficient magnitude to explain this puzzle.” The hypothesis of the submerged economy could also fit in the increase in revenues from the Treasury -they rise 17% until September-. The governor of the BdE himself recognized that he could not explain the 30% increase in this collection. He called them the “positive residuals”. Since the pandemic we have settled in the world of stages. There is no longer a single and clear path, but several with different probabilities. “We have become obsessed with economic forecasts when they are less reliable,” explained Minister Escrivá (who previously headed the independent tax authority, AIReF). “We can’t anticipate items for which we don’t have adequate quantitative instruments.” We have economists without answers. “Elementary, dear Watson.”