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We need to stop this never-ending and fruitless scenario analysis paralysis 


Natale Labia writes on the economy and finance. Partner and chief economist of a global investment firm, he writes in his personal capacity. MBA from Università Bocconi. Supports Juventus.

Central bankers and scenario planning: a tale of forecasts, assumptions, and the not-so-subtle art of predicting the unpredictable.

What is the difference between scenarios and forecasts? For those who follow the musings of central bankers, it would seem this question is becoming more pertinent, given the recent vogue for bankers and some academics to indulge in ‘scenario planning analysis’.

Most recently it was the governor of the Bank of England, Andrew Bailey, giving evidence to UK parliamentarians last week. He said that the former Federal Reserve chair Ben Bernanke, who is advising the bank on forecasting, was actively looking for a greater role in scenarios in future BoE analysis and policy making.

“If we were to use scenarios more” asked the Governor, “and present scenarios around a forecast, would that help?”

A fair question, but one which raises a few problems. First, anyone using the caveat “this is a scenario not a forecast” is simply removing their accountability for errors of analysis by invoking the possibility there are other, equally plausible, forecasts. It is a meaningless and distracting distinction.

But second, and more problematically, attributing importance to a set of scenarios risks misinterpreting the role of economists and indeed central bankers. Central bankers do not purport to make unconditional forecasts, akin to predicting “the sun will rise in the east tomorrow”. They are not in the business of predicting the future. All economic forecasts are conditional and depend on a series of assumptions relating to the path of interest rates, energy prices, the state of domestic and international politics and fiscal policy, among many other things.

The moment a forecast is conditional it is just a scenario with a particular set of assumptions. It is not the job of central bankers to make unconditional forecasts; that is best left to those who read palms or tea leaves.

But moreover, can scenario planning be useful, even if all it is is a set of different conditional forecasts? For example, in the pandemic, was it not helpful to look at the likely economic landscape under scenarios such as “a vaccine becomes available” and “new deadly Covid variants emerge”?

Maybe, in an extreme example such as a pandemic. Perhaps in this instance, scenario planning can represent an interesting thought experiment.

But one needs to be highly sceptical. For example, in the case of central banking, a decision on interest rates and monetary policy still needs to be made, which requires a base case forecast using conditional assumptions from data on the economy. A whole bunch of conflicting scenarios surely just serves as a pointless distraction, if not something that results in a poor decision.

Of course, followers of South African political thought will be no strangers to such scenario analysis. One of the earlier and better-known exponents was ex-Anglo American executive Clem Sunter, who has sold countless copies of books such as The Mind of a Fox on how to apply scenario analysis to everyday life. Self-described on his website as an “icon and model of mental litheness”, as well as a “Foxy Futurist”, Sunter became well known towards the end of the 1980s with his well-documented take on South Africa’s transition to democracy either taking the “High Road” of negotiations or a “Low Road” of Civil War, along with a number of “flags” pointing the way, for those ardent fox-like futurist scenario analysts.

Read more in Daily Maverick: ThinkFest: Clem Sunter on SA’s possible future(s)

As with all such analysts, Sunter did not stop in the 1990s — indeed his most recent articles and lectures deal with the current state of South Africa and its various potential “scenarios” for the future, encompassing a set of outcomes as diverse as “Wasteland” and “Switzerland”.

Other than potentially entertaining reading, it is hard to know how much value such analysis adds, or indeed what the point of it all is.

Of course, this application of scenario analysis to potential future outcomes of South Africa only forms part of a much broader canon of literature, there being a veritable cottage industry of books claiming to have some insights into the future of the country.

Indeed, it is hard to find a country where people are more obsessed with trying to know the patently unknowable. Perhaps it is symptomatic of some broader South African insecurity? Either way, the popularity of authors such as Sunter indicates a clear desire amongst South Africans to have some insights into what we all know is impossible to know. This tells one more about the “Mind of South Africa” — to quote the historian and journalist Allister Sparks — than any scenario analysis will ever tell one about the future of South Africa.

For those who are in the business of making decisions based on forecasts — like central bankers and decision-makers in politics and business — it would seem that scenarios are best avoided. Rather, focusing on the current data, basing assumptions on such data, and then building a conditional forecast thereon has as good a chance of achieving a decent outcome as anything.

Furthermore, to quote JM Keynes, “When the facts change, I change my mind — what do you do, sir?” Should the data change, then forecasts can shift accordingly.

Perhaps we could all benefit from returning to a more straightforward way of understanding the economy and dealing with the essentially unknowable. Everything else, scenario planning included, is just an unnecessary distraction. DM


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