LONDON, Sept 22 (Reuters Breakingviews) – Fifty years ago, policymakers were newly confident that they knew how to bring inflation down. The economist Milton Friedman and his “monetarist” followers had come up with a simple solution based, for the first time, on rigorous scientific analysis of the relevant economic data. Ensure that the money supply grew only slowly, they taught, and inflation would come under control.
At first it worked. Central bankers tamed money growth and inflation fell. But then the trusty relationship began to glitch. The money supply remained contained, but inflation roared back anyway.
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The British economist Charles Goodhart identified what had gone wrong. The relationship between the money supply and inflation had indeed been stable, so long as policymakers left the money supply to its own devices. Once they declared it to be a policy lever, however, banks changed how they behaved. Lenders busily improvised alternative gushers of liquidity not captured in the measured money supply, even as central bankers kept their fingers in the dyke. The target had been gamed. The link between money and inflation came unstuck.
Goodhart pointed out that this perverse result reflected a general rule. “Any observed statistical regularity” he said, “will tend to collapse once pressure is placed upon it for control purposes.”
For central bankers, Goodhart’s Law became a watchword for the dangers of relying on data-driven policy rules to manage the messy business of reality. Today, those same dangers are playing havoc with a much broader range of government policies. Two high-profile recent examples from the United Kingdom serve to demonstrate the point.
The first is immigration. Free movement of people between the European Union and Britain came to an end on December 31, 2020. Britain’s elected leaders were henceforth exclusively in charge, and the end of a politically corrosive decade of broken promises to reduce the number of new arrivals seemed finally to be at hand. Newly elected Prime Minister Boris Johnson leapt eagerly to the task. On January 1, 2021 he introduced a brand-new, “points-based” system specially designed to control immigration.
The root cause of this epochal policy failure was that the new, data-driven policy proved remarkably easy to game. The points system presented a conveniently visible target. A vibrant industry dedicated to hitting it sprouted overnight. As a result, the system’s meticulously designed settings rapidly got out of sync.
Instead, between 2019 and 2023, the number of care firms registered to sponsor visas exploded by over 200%. At the same time, many immigrants on care-related visas worked in the sector for only a few months, before moving on to other jobs. Nearly 680,000 carers and their dependents were admitted over 2021-24 – twenty times the government’s forecast. The care sector route became a short-circuit to circumvent the new thresholds imposed elsewhere. Britain’s new immigration policy had met its match in Goodhart’s Law.
The same mechanism explains another of the UK’s most high-profile policy challenges: the unplanned explosion in its sickness benefit bill.
Once again, the principal culprit is a points-based system that is vulnerable to being gamed. The OBR found that the proportion of claimant applications meeting the conditions to access benefits has rapidly increased in the last few years – despite surveys showing many illnesses in steady decline. Had the success rate instead remained stable, the OBR concluded, the increase in the number of approved claims between 2017 and 2022 would have as little as half the actual number. It is hard to escape the conclusion that Goodhart’s Law has struck again.
The lesson of Goodhart’s Law is that the real culprit may be more mundane: all too often, data-driven policymaking is the disease for which it claims to be the cure.
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Editing by Peter Thal Larsen; Production by Maya Nandhini
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Felix Martin is an economist, fund manager, and author. During a twenty-five year career in international finance Felix has managed and advised on funds investing in bond, currency, and credit markets globally at publicly listed asset managers, leading private firms, and his own independent boutique. He began his career at the World Bank in Washington, DC. He is also the author of “Money: The Unauthorised Biography”.