The
Big Mac index by The Economist
The
Big Mac index was invented by The Economist in 1986 as a
lighthearted guide to whether currencies are at their
"correct" level. It is based on the theory of
purchasing-power parity (PPP), the notion that in the long run
exchange rates should move towards the rate that would equalize the
prices of an identical basket of goods and services (in this case, a
burger) in any two countries. The Economist's basket contains
only a Big Mac, and relies on the efforts of McDonald’s to produce
identical products from the same ingredients everywhere (or almost
everywhere: for India we use the Maharaja Mac, which contains
chicken rather than beef). For example, the average price of a Big
Mac in America at the start of 2013 was $4.37; in China it was only
$2.57 at market exchange rates. So the "raw" Big Mac index
says that the yuan was undervalued by 41% at that time.
Burgernomics
was never intended as a precise gauge of currency misalignment,
merely a tool to make exchange-rate theory more digestible. Yet the
Big Mac index has become a global standard, included in several
economic textbooks and the subject of at least 20 academic studies.
For those who take their fast food more seriously, The Economist
has also calculated a gourmet version of the index.
The
Big Mac index suggests that currencies are particularly overvalued
in Norway, Switzerland and Brazil (see chart). The euro is now
around 12% too expensive relative to the dollar, according to the
gauge; in the summer of 2012 it was close to fair value. Currencies
in much of the emerging world, including Russia, China, and India,
are too cheap relative to the dollar on our gauge. Critics of
burgernomics say that you would expect average prices to be cheaper
in poor countries than in rich ones because labor costs are lower:
PPP signals where exchange rates should head over the long run, as a
country like China gets richer, not where prices should be right
now. Even so, the perennially undervalued yuan has scarcely moved
towards the Big Mac measure of fair value.
The
adjusted index addresses the criticism that you would expect average
burger prices to be cheaper in poor countries than in rich ones
because labor costs are lower. PPP signals where exchange rates
should be heading in the long run, as a country like China gets
richer, but it says little about today's equilibrium rate. The
relationship between prices and GDP per person may be a better guide
to the current fair value of a currency. The adjusted index uses the
"line of best fit" between Big Mac prices and GDP per
person for 48 countries (plus the euro area). The difference between
the price predicted by the red line for each country, given its
income per person, and its actual price gives a supersized measure
of currency under- and over-valuation.
For
a full and updated coverage of the Big Mac index visit
http://www.economist.com/topics/big-mac-index
and
enjoy the interactive features of the site.