The Big Mac index

The latest Big Mac index has just been published by The Economist. It is based on the theory of purchasing-power parity and uses McDonald's price data for the Big Mac to assess relative prices:

The cheapest burger in our chart is in China, where it costs $1.30, compared with an average American price of $3.15. This implies that the yuan is 59% undervalued.

This is unchanged from the last survey, in June 2005. On the basis of this index, neither the euro nor the pound are undervalued - though the Japanese yen, South African rand, Singapore and Aussie dollars certainly are.

For more on the index, see this page.

Comments

[Gabriel Mihalache]

I think that the results obtained this way are irrelevant because the assumptions under which we're working are too unrealistic. Purchasing-power parity might be OK in many cases but in this it prevents us from accounting for differences in demand structure, supply chain specificity and any price discrimination/discounts McDo. might be using to get brand loyalty going.

Too many things are implied constant for the 59% value to be of any usefulness, in my humble opinion.

I don't know why they didn't do the math for 50-100 products, with demand mostly invariant to geographic location, from different branches of the economy. I guess it would lose the novelty factor gained by mentioning the Big Mac. Can someone explain this one to me?

[sunship]

I don't know...I wouldn't be so quick to judge the relevance of the BMI. That said, it would be interesting to see how the BMI compares to other analysis of currency valuations with more relaxed assumptions. We may find out that BMI is fairly accurate and tasty.

[sunship]

Aha! Here we go...

hehehe "McParity" ... the economist's sense of humor is one of the attractions to this area for me.

Here is the data:
ftp://anonymous@ftp.icpsr.umich.edu/pub/PRA/outgoing/s1298/

I found various articles through Lexis-Nexis and Proquest for further reading.

I haven't taken a look yet since I have, coincidentally, an economics course to get to, and a 2.5 mile walk. The summary from a paper on the data cited above (I couldn't find the actual paper tho):

The theory of purchasing power parity (PPP) has long been a staple of international economic analysis. Recent years have seen the rise in popularity of a tongue-in-cheek, fastfood version of PPP: The Big Mac index. In this article, Michael Pakko and Patricia Pollard describe how comparisons of Big Mac prices around the world contain the ingredients necessary to demonstrate the fundamental principles of PPP. They show that the Big Mac index does nearly as well as more comprehensive measures of international price comparisons and that deviations from "McParity" illustrate why PPP often appears not to hold as a practical matter.

[Taught intermediate macro 10 years]

1. It compares homogenous products. The more aggregated the measure of prices, the more likely the comparisons are for heterogenous products. Tests of PPP with aggregate price indexes (like the CPI) are worthless because of variation in the baskets of goods.
2. It's a relatively strong test of PPP. PPP holds, in part, because of arbitrage opportunities. There are clearly no arbitrage opportunities in the market for Big Macs

[Norman Berger]

The Big Mac index was proven to have predictive value by the St. Louis Fed not too long ago. Let us assume that the BMI is accurate. That would mean that China's $209B of increased reserves for 2005 included a future currency loss of $123B, ala BMI, which is 6.2% of their GDP.

Further, with the foreign reserves announcement we were informed that another $60B was not included in the increase in foreign reserves because it was 'used' to infuse capital into trouble banks which means that these banks allowed $60B to be spent that was not productive. The $60B is 3% of China's GDP. (Also, in equivalent U.S. GDP terms the bank losses would be $370B!)

So the currency loss added to the bank losses is 9.2% of GDP. That's about what China says was their GDP growth. I think actual GDP was flat for 2005. By the way, companies do this all the time: They overstate their balance sheets and puff up their income statements. Enron, anyone?