Recently, I have been doing some business planning as part of Limerick’s LEAP programme. One of the things they teach you is the importance of realistic financial planning. Realistic means that the numbers reflect known facts and uncertainties. Projections on a timeframe of 3 or 4 years often turn out wrong, but an unrealistic plan is worse than useless.
With the arrival of the IMF in late 2010, the then Irish government published a Four Year Plan for National Economic Recovery. A key assumption is Nominal GDP growth rates for the years 2011-2014. (“Nominal” means not adjusted for inflation.) The plan contains pessimistic and optimistic growth scenarios. Are these numbers realistic?
The history of Irish 4-year Nominal GDP growth is shown below (uncompounded e.g. the rate for 1961 is the sum of rates for 1961,1962,1963 & 1964). The two scenarios from the Four Year Plan are grafted on the end.
How likely is it that the outcome will lie within the expected forecast range? One way to answer this question is to treat historical growth rates as random numbers drawn from a probability distribution. The empirical 4-year growth probability distribution (along with the goverment’s forecast range) is shown below.
The shaded area gives the probability that the 2011-2014 outcome is between the governments pessimistic and optimistic projections. The probability is about 40%. A less than 50% chance that growth falls between the two limiting cases is poor. The Four Year Plan is not realistic in the sense that the range of uncertainty in the forecasts should be increased.
There is some good news here. A more realistic plan will include more optimistic growth scenarios.