Goodhart’s Law

From Open Risk Manual

Definition

Goodhart’s Law states that any observed statistical regularity will tend to collapse once pressure is placed upon it for control purposes. An alternative expression states: When a measure becomes a target, it ceases to be a good measure.

Implications

Regulatory Frameworks

On the roles of regulatory frameworks is to prevent unwanted behavior in the financial system (e.g., excessive risk taking). Towards that aim, policymakers devise policies that specifically target a given failure mode (e.g., high concentration in certain markets). These policies may employ indicators, risk metrics or related information tools that aim to succinctly establish compliance with the policy. After implementation, it may be observed that the policy does not work as intended. This follows from the involved (regulated) parties circumventing the spirit of policies by engaging into equivalent activities that are not affected by the regulation.

  • Indicators may lose their predictive power when relied on for regulatory purposes BCBS 258
  • The fitness of risk models for control purposes may be compromised, i.e., no risk model can take account ex-ante of the ways in which it might be gamed by involved parties.
  • The case against leverage ratios is that they may encourage banks to increase their risk per unit of assets, reducing their usefulness as an indicator of bank failure[1]

Economic Policies

Similarly, in broader economic context, if an economic indicator or index becomes a target for conducting social or economic policy, it will lose the information qualities that qualify it to play such a role in the first place.

See Also

References

  1. The dog and the frisbee, Andrew G Haldane, Vasileios Madouros, Economist, Bank of England, 2012