Forecasting

Creating and Presenting Strategic Plans

Forecasting

Difficult

Vital

Approaches

Numbers Descriptive Adaptive Models

Forecasting

Numbers

Numbers

Precise estimates

http://www.worldbank.org/en/publication/global-economic-prospects/summary-table

Numbers

February 2015There are considerable uncertainties surrounding the projections of GDP growth and CPI inflation published in the Inflation Report. This uncertainty is reflected by the presentation of projections as fan charts. The fan charts are derived from the MPC's projected probability distributions for the annual rate of CPI inflation and four-quarter growth rate of GDP.

Estimates with probabilities

http://www.bankofengland.co.uk/publications/Pages/inflationreport/irprobab.aspx

6%

What’s to be done?

…The MPC’s recent forecast performance has been noticeably worse than prior to

the crisis, and marginally worse than that of outside forecasters. The forecast

errors of the MPC have been characterized by persistent over-prediction of output

growth and persistent under- prediction of CPI inflation…

….The central model used by staff for processing news and judgments .. is a

Dynamic Stochastic General Equilibrium (DSGE) model with a relatively

parsimonious 16 variables at its core…

…there may be too few incentives and opportunities for staff to seriously

challenge the MPC

…Some former MPC members… reported that they encountered difficulties

getting divergent points of view to be seriously considered in the forecasting

process.

Report on Monetary Policy Committee’s Forecasting Capability, 2012

Source: REVIEW OF THE MONETARY POLICY COMMITTEE’S FORECASTING CAPABILITY Report by David Stockton http://www.bankofengland.co.uk/publications/Documents/news/2012/cr3stockton.pdf

The ECB record

Date Event ECB Forecast

9 August 2007

BNP Paribas ceases trading in 3 US hedge funds

specialising in US mortgage debt

‘The outlook for the external environment…remains favourable’

15 Septembe

r 2008

US Government allows Lehman Brothers to go

bankrupt

‘…..growth in the world economy is expected to remain relatively resilient.’

2 April 2009

G20 Summit agrees $5tn fiscal expansion of $1.1tn to

help IMF

‘….However, the risks to global activity appear to be broadly balanced.’

9 May 2010

Governments declared insolvent: Financial aid to

Greece debt crises

‘Global economic prospects remain subject to high levels of uncertainty. On the one hand, there are concerns that the financial market turmoil could have a greater impact on the real economy, as well as fears that protectionist pressures could intensify ….On the other hand, there may be stronger than anticipated positive effects due to the decrease in commodity prices…

5 August 2011

America’s debt loses triple A status

Looking ahead, the expected gradual retreat of some adverse transitory factors should support world economic activity in the second half of the year.…. In emerging economies, the growth outlook remains buoyant…’https://www.ecb.europa.eu/pub/economic-bulletin/mb/html/index.en.htmlSource:

Forecasting: An astonishing record of complete failure

2001: The accuracy of economic forecasts in the 1990s

1. All much the same: IMF, World Bank and private forecasters.

2. The predictive record of economists was terrible.

“The record of failure to predict recessions is virtually unblemished.”

An astonishing record – of complete failure By Tim Harford: Source http://www.ft.com/cms/s/2/14e323ee-e602-11e3-aeef-00144feabdc0.html

The accuracy of economic forecasts from 2007

2008: no recessions in 2009: most of world.

2011 Spring: no recessions in 2012:15 occurred.

Conclusion on Forecasting Numbers

Dreadful

Forecasting

Descriptive

Why?

‘If you know all possible conditions of a physical system you can, in theory,

project its behavior into the future. But this only concerns inanimate objects.

We hit a stumbling block when social matters are involved. It is another matter

to project a future when humans are involved if you consider living beings and

endowed with free will. …However. if you believe in free will you can’t truly

believe in social sciences and economic projection. You cannot predict how

people will act….

… In orthodox economics, rationality became a straitjacket. Platonified

economists ignored the fact that people might prefer to do something other than

maximise their economic interests. This led to mathematical techniques such as

‘maximization’ or ‘Optimization’ on which Paul Samuelson built much of his work.

I would not be the first to say that this optimisation set back social science by

reducing it from the intellectual and reflective discipline that it was becoming an

attempt be an ‘exact science’. By ‘exact science’ I mean a second rate

engineering problem for those who want to pretend that they are in the physics

department - so-called physics envy. In other words an intellectual fraud.’Source: Taleb, N. N. (2007), The Black Swan: The Impact of the Highly Improbable, Penguin books.

2007: Published: Before the banking crisis

Seismic Shocks

What’s to be done?

‘As a result of demographics, the Soviet Union thus faces internal problems

for which communism has no answers. It will have to retrench either

industrially or militarily, or it will have to reform the collective farm, which

can hardly be done without political convulsion. It cannot escape the rising

tensions between the populations of a developed European Russia and the

fast-growing populations of an Asian Russia. Within the next twenty five

years, the Soviet Union will be faced with the same kind of racial, ethnic,

religious and cultural tensions that have split apart all other nineteenth

century empires since World War II.’

Drucker, P., (1980), Managing in Turbulent Times, p. 90 Heinemann, London.

1980: 11 years before the end of the Soviet Union December 1991

Process and structure

Process: listening to people

No figures or mathematical models

Unfairness: Poverty, food, religion, regions, race

Forecasting

Adaptive Models

Adaptive models

Adapt to change

Build ‘What if’ scenarios

Discussion before numbers

Disruptive change

Stage 1: Descriptive

Just words

Scenarios

Those involved

Group diversity

Listening

Sales 201X to 201Z

By Product

By Territory

By Customer

Stage 2: Adaptive Model

Sales 201X to 201Z

By Product

By Territory

By Customer

Ratios

Profitability

Assets

Liquidity

Leverage

Income Statement

For Firm

Balance Sheet

For Firm

Cash Flows

For Firm

Sales 201X to 201Z

By Product

By Territory

By Customer

Discussion leading to this

Expected

Best

Worst

For each scenario

A commentary on risk

The end