Draw a line on just drawing a line
Scenario analysis is essential in uncertain times, but it must be well-grounded, not just drawing an arbitrary line on a graph.
- You know times are uncertain when institutions start publishing scenarios alongside their normal forecasts. Two principles underlie good scenarios. First, the narrative underlying the scenario must hang together – no assuming people do things that are either individually irrational or infeasible. Second, the scenario must allow people to respond to the initial shock – avoid just drawing a price line on a graph and assuming people cannot adjust their behaviour.
- There is a tension, though, between the need to be realistic and a desire to highlight vulnerabilities or contemplate worst-case scenarios. There is a legitimate role for worst-case thinking, but it must be handled with care. Recall that even though our forecasts last year were less alarmist than many in the wake of Liberation Day, actual outcomes were even better than we had expected.
- The real value of scenarios is teasing out downstream effects and delayed responses. Sometimes the responses to temporary shocks can have lasting effects. From EV purchases to defence budgets, these could be especially important coming out of the current conflict. All the more reason to avoid just drawing a line and assuming that is the outcome.
In times as uncertain as these, you want to be able to articulate more than one possible future state of the world. That is where scenario analysis comes in. Indeed, when institutions start publishing scenarios, you can take it as a sign that things are unusually uncertain. The RBA used scenarios extensively during the pandemic. And while the IMF did not give scenarios any prominence in its previous full World Economic Outlook report in October, it did this week. Similarly, we have published several scenario iterations over the past six weeks and will provide an update later today in our Market Outlook report.
Using scenarios rather than simple uncertainty ranges or a description of risks is especially useful when the possible future states of the world are qualitatively different from the base case, and when the level of conviction about that base case is low. There is nothing wrong with a scenario that is only a little different from the base case, but it is not that interesting or informative.
Two key principles underlie good scenario analysis. First, the premise of the scenario needs to be well-grounded. The narrative motivating the initial impetus must hang together. It must be logically consistent and represent both the interests and the constraints of the actors within the system. In other words, scenarios should not assume that people do things that are either bonkers or infeasible. Individually rational behaviour that is harmful in aggregate, such as panic-buying toilet paper or conducting fire-sales of loss-making assets, should of course be allowed for, but make sure the action is indeed individually rational.
Second, the methods used in developing the scenario need to go beyond first-round thinking. You need to allow for other people to react. A good scenario cannot be just a one-off shock where nothing else changes. Sometimes it takes time for people to adjust to the new situation, so the reaction occurs with a lag. Teasing these reactions out is the value-add of the scenario.
There is a tension, though, between the need to be realistic and a desire to highlight vulnerabilities or contemplate worst-case scenarios. Sometimes a lack of realism is used to guard against a potential failure of imagination. There is a legitimate role for this approach when stress testing, for example. However, unrealistic assumptions in forecast-flavoured scenarios leave your forecasts open to misinterpretation. We have seen an example of this issue this week, where the IMF’s worst-case ‘severe’ scenario, which implies a global recession, has sparked unhelpful talk of recession here in Australia.
Part of the issue is that the IMF’s less-bad ‘adverse’ scenario (which assumes oil prices average USD100/bbl this year before moderating to USD75 next year) and worst-case ‘severe’ scenario (which assumes oil prices stay around USD125/bbl from the outbreak of the conflict all the way through to end-2027) are both ‘top-down’ scenarios that appear to start from an assumed path for oil prices. Unlike our own scenario work, they do not explicitly model loss of supply from the Middle East and work out what prices need to do to clear the global market. By effectively just drawing a line on a graph for oil prices, the scenarios assume away any scope for other producers to respond. This is not an issue in the near term, but the longer the assumption is maintained, the less realistic it is. High prices will spur non-OPEC producers such as the US and Canada to boost production. It takes time to get that expansion running, but eventually prices will start to ease.
Because it assumes high prices right through 2027, the ‘severe’ scenario is most challenged by this issue. This is not to say that the IMF should not have published that scenario, but it is important to understand the context and what it was trying to achieve in doing so.
When developing scenarios, you also need to avoid the trap of thinking only of downside risks. Part of the problem is that downside risks usually come from identifiable events. It is easy to construct a plausible narrative for a scenario starting from “this particular bad thing happened”. But as one of my old bosses used to remind us, sometimes you should also consider the risk everything just turns out a little bit better than expected.
As our April Market Outlook goes to publication later today, it is helpful to recall last April’s edition. The ‘Liberation Day’ tariffs had been announced a fortnight previously, and many voices in the market were predicting global or US recessions. At the time we took a more moderate view, based on the principles noted above. Firstly, continuing with very high tariff rates would have been an act of economic self-harm. While it was hard to bet on the Trump administration acting rationally in a context of ‘flood the zone’ headlines and intemperate social media posts, self-interest is still the best assumption. If there is nothing preventing someone from stopping punching themselves in the face, they will stop punching.
Secondly – and this was a key judgement in our forecast last year – other countries had agency and could respond. In particular, China had scope to stimulate, and this would also cushion growth in Australia. In that context, we note that the latest Chinese GDP growth has again surprised on the upside relative to market expectations.
It turns out that even we were too bearish a year ago: the global economy did much better than expected, and global trade kept expanding with barely a hiccup. Other factors, including a tech boom, turned out to be more important than expected. Trade patterns were also re-routed around the highest tariffs, and of course the US government de-escalated, as is proving to be its pattern.
These principles also hold for other kinds of scenarios. Whenever you read a prediction of doom concerning, say, adoption of a new technology, ask yourself what is preventing people from responding to ameliorate the bad thing. What prevents macroeconomic policymakers from easing, for example, or the tax system from redistributing unequal gains? While occasionally decision-makers decide that a bad thing is good actually, holding that position is itself fragile.
Where scenarios can really add value is when they highlight a lasting effect from a temporary shock. Whether it is the person who buys an EV in response to current high petrol prices and reduces their petrol consumption permanently, or the government that reassesses its defence spending, behavioural responses can change longer-term demand trends, and so the prices that prevail further out. Normalisation after a shock does not always take you back to where you were. That is another reason why it is so important to avoid just drawing a line on a graph and calling it a scenario, ignoring system-wide effects.
Stay informed with Westpac IQ
Get the latest reports straight to your inbox.
Related articles
Australia and NZ Weekly 13 April 2026
Australia and NZ Weekly 13 April 2026
On hoping you’ll be wrong
Browse topics
Disclaimer
©2026 Westpac Banking Corporation ABN 33 007 457 141 (including where acting under any of its Westpac, St George, Bank of Melbourne or BankSA brands, collectively, “Westpac”). References to the “Westpac Group” are to Westpac and its subsidiaries and includes the directors, employees and representatives of Westpac and its subsidiaries.
Things you should know
We respect your privacy: You can view the New Zealand Privacy Policy here, or the Australian Group Privacy Statement here. Each time someone visits our site, data is captured so that we can accurately evaluate the quality of our content and make improvements for you. We may at times use technology to capture data about you to help us to better understand you and your needs, including potentially for the purposes of assessing your individual reading habits and interests to allow us to provide suggestions regarding other reading material which may be suitable for you.
This information, unless specifically indicated otherwise, is under copyright of the Westpac Group. None of the material, nor its contents, nor any copy of it, may be altered in any way, transmitted to, copied of distributed to any other party without the prior written permission of the Westpac Group.
Disclaimer
This information has been prepared by Westpac and is intended for information purposes only. It is not intended to reflect any recommendation or financial advice and investment decisions should not be based on it. This information does not constitute an offer, a solicitation of an offer, or an inducement to subscribe for, purchase or sell any financial instrument or to enter into a legally binding contract. To the extent that this information contains any general advice, it has been prepared without taking into account your objectives, financial situation or needs and before acting on it you should consider the appropriateness of the advice. Certain types of transactions, including those involving futures, options and high yield securities give rise to substantial risk and are not suitable for all investors. We recommend that you seek your own independent legal or financial advice before proceeding with any investment decision.
This information may contain material provided by third parties. While such material is published with the necessary permission none of Westpac or its related entities accepts any responsibility for the accuracy or completeness of any such material. Although we have made every effort to ensure this information is free from error, none of Westpac or its related entities warrants the accuracy, adequacy or completeness of this information, or otherwise endorses it in any way. Except where contrary to law, Westpac Group intend by this notice to exclude liability for this information. This information is subject to change without notice and none of Westpac or its related entities is under any obligation to update this information or correct any inaccuracy which may become apparent at a later date. This information may contain or incorporate by reference forward-looking statements. The words “believe”, “anticipate”, “expect”, “intend”, “plan”, “predict”, “continue”, “assume”, “positioned”, “may”, “will”, “should”, “shall”, “risk” and other similar expressions that are predictions of or indicate future events and future trends identify forward-looking statements. These forward-looking statements include all matters that are not historical facts. Past performance is not a reliable indicator of future performance, nor are forecasts of future performance. Whilst every effort has been taken to ensure that the assumptions on which any forecasts are based are reasonable, the forecasts may be affected by incorrect assumptions or by known or unknown risks and uncertainties. The ultimate outcomes may differ substantially from any forecasts.
Conflicts of Interest: In the normal course of offering banking products and services to its clients, the Westpac Group may act in several capacities (including issuer, market maker, underwriter, distributor, swap counterparty and calculation agent) simultaneously with respect to a financial instrument, giving rise to potential conflicts of interest which may impact the performance of a financial instrument. The Westpac Group may at any time transact or hold a position (including hedging and trading positions) for its own account or the account of a client in any financial instrument which may impact the performance of that financial instrument.
Author(s) disclaimer and declaration: The author(s) confirms that (a) no part of his/her compensation was, is, or will be, directly or indirectly, related to any views or (if applicable) recommendations expressed in this material; (b) this material accurately reflects his/her personal views about the financial products, companies or issuers (if applicable) and is based on sources reasonably believed to be reliable and accurate; (c) to the best of the author’s knowledge, they are not in receipt of inside information and this material does not contain inside information; and (d) no other part of the Westpac Group has made any attempt to influence this material.
Further important information regarding sustainability-related content: This material may contain statements relating to environmental, social and governance (ESG) topics. These are subject to known and unknown risks, and there are significant uncertainties, limitations, risks and assumptions in the metrics, modelling, data, scenarios, reporting and analysis on which the statements rely. In particular, these areas are rapidly evolving and maturing, and there are variations in approaches and common standards and practice, as well as uncertainty around future related policy and legislation. Some material may include information derived from publicly available sources that have not been independently verified. No representation or warranty is made as to the accuracy, completeness or reliability of the information. There is a risk that the analysis, estimates, judgements, assumptions, views, models, scenarios or projections used may turn out to be incorrect. These risks may cause actual outcomes to differ materially from those expressed or implied. The ESG-related statements in this material do not constitute advice, nor are they guarantees or predictions of future performance, and Westpac gives no representation, warranty or assurance (including as to the quality, accuracy or completeness of the statements). You should seek your own independent advice.
Additional country disclosures:
Australia: Westpac holds an Australian Financial Services Licence (No. 233714). You can access Westpac’s Financial Services Guide here or request a copy from your Westpac point of contact. To the extent that this information contains any general advice, it has been prepared without taking into account your objectives, financial situation or needs and before acting on it you should consider the appropriateness of the advice.
New Zealand: In New Zealand, Westpac Institutional Bank refers to the brand under which products and services are provided by either Westpac (NZ division) or Westpac New Zealand Limited (company number 1763882), the New Zealand incorporated subsidiary of Westpac ("WNZL"). Any product or service made available by WNZL does not represent an offer from Westpac or any of its subsidiaries (other than WNZL). Neither Westpac nor its other subsidiaries guarantee or otherwise support the performance of WNZL in respect of any such product. WNZL is not an authorised deposit-taking institution for the purposes of Australian prudential standards. The current disclosure statements for the New Zealand branch of Westpac and WNZL can be obtained at the internet address www.westpac.co.nz.
Singapore: This material has been prepared and issued for distribution in Singapore to institutional investors, accredited investors and expert investors (as defined in the applicable Singapore laws and regulations) only. Recipients of this material in Singapore should contact Westpac Singapore Branch in respect of any matters arising from, or in connection with, this material. Westpac Singapore Branch holds a wholesale banking licence and is subject to supervision by the Monetary Authority of Singapore.
Fiji: Unless otherwise specified, the products and services for Westpac Fiji are available from www.westpac.com.fj © Westpac Banking Corporation ABN 33 007 457 141. This information does not take your personal circumstances into account and before acting on it you should consider the appropriateness of the information for your financial situation. Westpac Banking Corporation ABN 33 007 457 141 is incorporated in NSW Australia and registered as a branch in Fiji. The liability of its members is limited.
Papua New Guinea: Unless otherwise specified, the products and services for Westpac PNG are available from www.westpac.com.pg © Westpac Banking Corporation ABN 33 007 457 141. This information does not take your personal circumstances into account and before acting on it you should consider the appropriateness of the information for your financial situation. Westpac Banking Corporation ABN 33 007 457 141 is incorporated in NSW Australia. Westpac is represented in Papua New Guinea by Westpac Bank - PNG - Limited. The liability of its members is limited.
U.S.: Westpac operates in the United States of America as a federally licensed branch, regulated by the Office of the Comptroller of the Currency. Westpac is also registered with the US Commodity Futures Trading Commission (“CFTC”) as a Swap Dealer, but is neither registered as, or affiliated with, a Futures Commission Merchant registered with the US CFTC. The services and products referenced above are not insured by the Federal Deposit Insurance Corporation (“FDIC”). Westpac Capital Markets, LLC (‘WCM’), a wholly-owned subsidiary of Westpac, is a broker-dealer registered under the U.S. Securities Exchange Act of 1934 (‘the Exchange Act’) and member of the Financial Industry Regulatory Authority (‘FINRA’). In accordance with APRA's Prudential Standard 222 'Association with Related Entities', Westpac does not stand behind WCM other than as provided for in certain legal agreements between Westpac and WCM and obligations of WCM do not represent liabilities of Westpac.
This communication is provided for distribution to U.S. institutional investors in reliance on the exemption from registration provided by Rule 15a-6 under the Exchange Act and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors in the United States. WCM is the U.S. distributor of this communication and accepts responsibility for the contents of this communication. Transactions by U.S. customers of any securities referenced herein should be effected through WCM. All disclaimers set out with respect to Westpac apply equally to WCM. If you would like to speak to someone regarding any security mentioned herein, please contact WCM on +1 212 389 1269. Investing in any non-U.S. securities or related financial instruments mentioned in this communication may present certain risks. The securities of non-U.S. issuers may not be registered with, or be subject to the regulations of, the SEC in the United States. Information on such non-U.S. securities or related financial instruments may be limited. Non-U.S. companies may not be subject to audit and reporting standards and regulatory requirements comparable to those in effect in the United States. The value of any investment or income from any securities or related derivative instruments denominated in a currency other than U.S. dollars is subject to exchange rate fluctuations that may have a positive or adverse effect on the value of or income from such securities or related derivative instruments.
The author of this communication is employed by Westpac and is not registered or qualified as a research analyst, representative, or associated person of WCM or any other U.S. broker-dealer under the rules of FINRA, any other U.S. self-regulatory organisation, or the laws, rules or regulations of any State. Unless otherwise specifically stated, the views expressed herein are solely those of the author and may differ from the information, views or analysis expressed by Westpac and/or its affiliates.
UK: The London branch of Westpac is authorised in the United Kingdom by the Prudential Regulation Authority (PRA) and is subject to regulation by the Financial Conduct Authority (FCA) and limited regulation by the PRA (Financial Services Register number: 124586). The London branch of Westpac is registered at Companies House as a branch established in the United Kingdom (Branch No. BR000106). Details about the extent of the regulation of Westpac’s London branch by the PRA are available from us on request.
This communication is not being made to or distributed to, and must not be passed on to, the general public in the United Kingdom. Rather, this communication is being made only to and is directed at (a) those persons falling within the definition of Investment Professionals (set out in Article 19(5) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005 (the “Order”)); (b) those persons falling within the definition of high net worth companies, unincorporated associations etc. (set out in Article 49(2)of the Order; (c) other persons to whom it may lawfully be communicated in accordance with the Order or (d) any persons to whom it may otherwise lawfully be made (all such persons together being referred to as “relevant persons”). Any person who is not a relevant person should not act or rely on this communication or any of its contents. In the same way, the information contained in this communication is intended for “eligible counterparties” and “professional clients” as defined by the rules of the Financial Conduct Authority and is not intended for “retail clients”. Westpac expressly prohibits you from passing on the information in this communication to any third party.
European Economic Area (“EEA”): This material may be distributed to you by either: (i) Westpac directly, or (ii) Westpac Europe GmbH (“WEG”) under a sub-licensing arrangement. WEG has not edited or otherwise modified the content of this material. WEG is authorised in Germany by the Federal Financial Supervision Authority (‘BaFin’) and subject to its regulation. WEG’s supervisory authorities are BaFin and the German Federal Bank (‘Deutsche Bundesbank’). WEG is registered with the commercial register (‘Handelsregister’) of the local court of Frankfurt am Main under registration number HRB 118483. In accordance with APRA’s Prudential Standard 222 ‘Association with Related Entities’, Westpac does not stand behind WEG other than as provided for in certain legal agreements (a risk transfer, sub-participation and collateral agreement) between Westpac and WEG and obligations of WEG do not represent liabilities of Westpac. Any product or service made available by WEG does not represent an offer from Westpac or any of its subsidiaries (other than WEG). All disclaimers set out with respect to Westpac apply equally to WEG.
This communication is not intended for distribution to, or use by any person or entity in any jurisdiction or country where such distribution or use would be contrary to local law or regulation.
This communication contains general commentary, research, and market colour. The communication does not constitute investment advice. The material may contain an ‘investment recommendation’ and/or ‘information recommending or suggesting an investment’, both as defined in Regulation (EU) No 596/2014 (including as applicable in the United Kingdom) (“MAR”). In accordance with the relevant provisions of MAR, reasonable care has been taken to ensure that the material has been objectively presented and that interests or conflicts of interest of the sender concerning the financial instruments to which that information relates have been disclosed.
Investment recommendations must be read alongside the specific disclosure which accompanies them and the general disclosure which can be found here. Such disclosure fulfils certain additional information requirements of MAR and associated delegated legislation and by accepting this communication you acknowledge that you are aware of the existence of such additional disclosure and its contents.
To the extent this communication comprises an investment recommendation it is classified as non-independent research. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and therefore constitutes a marketing communication. Further, this communication is not subject to any prohibition on dealing ahead of the dissemination of investment research.