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Goodharts law

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Goodharts law

Goodhart's law is named after the banker who originated it, Charles Goodhart. Its most popular formulation is: "When a measure becomes a target, it ceases to be a good measure."

The original formulation by Goodhart, a former advisor to the Bank of England and Emeritus Professor at the London School of Economics, is this: "As soon as the government attempts to regulate any particular set of financial assets, these become unreliable as indicators of economic trends." This is because investors try to anticipate what the effect of the regulation will be, and invest so as to benefit from it. Goodhart first used it in a 1975 paper, and it later became used popularly to criticize the United Kingdom government of Margaret Thatcher for trying to conduct monetary policy on the basis of targets for broad and narrow money. However, the concept is considerably older, and closely related ideas are known under different names, e.g. Campbell's Law (1976), and the Lucas critique (1976). The law is implicit in the economic idea of rational expectations. While it originated in the context of market responses the law has profound implications for the selection of high-level targets in organisations.[1]

Expressions

  • Any observed statistical regularity will tend to collapse once pressure is placed upon it for control purposes.
(Goodhart's original 1975 formulation, reprinted on p. 116 in Goodhart 1981[2])
  • A risk model breaks down when used for regulatory purposes. (Daníelsson, 2002)
(Daníelsson formally labels this a corollary of Goodhart's Law.)

See also

References

  • K. Alec Chrystal and Paul D. Mizen, 2001,
  • Daníelsson, Jón. "The Emperor Has No Clothes: Limits to Risk Modelling." Journal of Banking and Finance, 2002, 26, pp. 1273–96.
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