Actuaries Institute warns of low probability, high-impact economic scenarios

“Scenario analysis is widely used by the government, regulators, and businesses. It has wide application across all sectors of the economy and allows the impact of myriad factors to be assessed, such as climate change, cyber, and pandemic risks – key challenges all organisations are currently facing,” said Actuaries Institute president Annette King.

Actuary Dr. Hugh Miller, who collaborated on the green paper with independent economist Michael Blythe, added: “Scenario analysis delivers large benefits by investigating potential futures that may be low probability but high impact. These are the types of shocks that cause the greatest disruption and require the greatest adjustments. Understanding the implications and having a game plan in place are powerful supports for decision makers.”

Scenarios

Baseline scenario

Dr. Miller further stated that the baseline scenario, the benchmark for the “alternative futures,” is the only one avoiding a recession with positive, though modest, GDP growth rates, but still involves rising downward risks.

Stagflation

Assessing the chance of stagflation, the green paper warns that it is plausible for Australia to experience stagflation in the current environment that includes high energy and food prices, supply chain pressures, strong demand, and earlier reflationary policy settings.

Correction in house prices

A major house price correction is another alternative future, with the scenario based on a 30% drop in dwelling places, beyond all current mainstream projections.

“The price decline is triggered by an overly aggressive Reserve Bank tightening cycle that leads to a cascading effect across the economy and financial system,” the green paper said. “Again, while most key economic variables converge back to the baseline projections towards the end of the scenario, the economy is smaller than in the baseline by the end, this time by 2%. The unemployment rate and debt servicing ratio are crucial variables to watch for this scenario.”

Modern monetary theory

Adopting modern monetary theory focuses on achieving full employment by funding government expenditure through creating money rather than issuing debt, a “new paradigm” scenario.

“The activity benefits of the MMT-driven boom largely evaporate during the subsequent recession,” the green paper said.

King said the scenarios highlight the need for policymakers, advisers, and the industry to stay alert.

“If under plausible scenarios a business model is found unsustainable, clearly change is required – to the service or product offered, the public policy or regulatory settings in the market, or both,” she said.

Actuaries Institute is the peak professional body representing the actuarial profession in Australia. It has been operating in Australia for 125 years, recently reaffirming its commitment to promoting and maintaining a high standard of actuarial practice in the country.