Sarah Hunter: Shedding light on uncertainty - using scenarios in forecasting and policy

Speech by Ms Sarah Hunter, Assistant Governor (Economic) of the Reserve Bank of Australia, at the University of Adelaide South Australian Centre for Economics Studies (SACES) Lunch, Adelaide, 13 December 2024.

The views expressed in this speech are those of the speaker and not the view of the BIS.

I would first like to pay respect to the traditional and original owners of this land, the Kaurna people, to pay respect to those who have passed before us and to acknowledge today's custodians of this land. I also extend that respect to any First Nations people joining us.

Today I am going to talk about how the RBA uses scenarios – that is, alternative possible pathways for the economy to help us think through the outlook for the economy and set monetary policy.

Our baseline forecast of how the economy may evolve is a key input to the monetary policy decision. It represents what we think is the most likely single path for the economy. But it's only one path, and the chance of that precise path being the one that happens is approximately zero. So, acknowledging the uncertainty inherent in our forecasts is core to making good policy decisions.

The systematic use of scenario analysis is common in many professions where decisions are made under uncertainty – economists are not alone in not knowing exactly how things will play out. For example, scenario analysis is a fundamental part of financial stress testing exercises that are conducted on a regular basis by prudential regulators. Many central banks use scenarios internally to inform their policy decisions, and some publish them. The value of scenarios has been re-emphasised by the recent Bernanke Review of the Bank of England and our own RBA Review, which recommended greater use of scenarios to inform policy.

So, why are scenarios useful?