Charles Goodhart

Goodhart’s Law: 40 years on

Few economists earn the privilege of having an economic law being named after them. Charles Goodhart, distinguished in the field of monetary policy and financial markets, is one such individual.

It was back in 1975 at the London School of Economics that he made a decisive realisation, that “any observed statistical regularity will tend to collapse once pressure is placed upon it for control purposes.”. Put simply, “when a measure becomes a target, it ceases to become a good measure”.

The most famous example of this was during Margaret Thatcher’s government, when her chancellor Geoffrey Howe observed a relationship between the official interest rate and the money supply, and the money supply and nominal incomes. This led him to mistakenly attempt to target the growth rate of the money supply (M3) by using the official interest rate, only to overshoot the target by 100% in the first two-and-a-half years whilst failing to raise nominal incomes by nearly as much. In this case, the fundamental relationship between the variables changed and Goodhart’s law prevailed.

Fast forward 40 years to today and Goodhart’s law is still very much well and alive. Here’s a more recent and vibrant example; consider President Obama’s Race to the Top programme for education reform. Teachers were judged on the test score performance of their pupil, as the rationale is that better test scores are correlated with better school
quality. However, the very act of targeting test scores changes the fundamental relationship between the variables as it gives the incentive for dishonest teachers to cheat and it forces honest teachers to devote time away from teaching the material towards passing the test. Consequently, the relationship between school quality and test scores deteriorates, proving that Goodhart’s law is both timeless and ubiquitous.

Charles Goodhart, of Goodhart’s law, is coming to Cambridge on the 24th November to speak about ‘Alternative Theories of the Determination of the Money Supply‘ in King’s College Cambridge! Don’t miss out on what promises to be enthralling lecture from such a distinguished individual in the field of economics.