The ‘BIG MAC Index’ used to identify overpriced currencies…but is it worth the Cholesterol?

THE Big Mac index celebrates its 25th birthday this year. Invented by The Economist in 1986 as a lighthearted guide to whether currencies are at their “correct” level, it 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. American politicians have even cited the index in their demands for a big appreciation of the Chinese yuan. With so many people taking the hamburger standard so seriously, it may be time to beef it up.

Burgernomics 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 equalise the prices of an identical basket of goods and services (in this case, a burger) in any two countries. The average price of a Big Mac in America is $4.07; in China it is only $2.27 at market exchange rates, 44% cheaper. In other words, the raw Big Mac index suggests that the yuan is undervalued by 44% against the dollar. In contrast, the currencies of Switzerland and Norway appear to be overvalued by around 100%. The euro (based on a weighted average of prices in member countries) is overvalued by 21% against the dollar; sterling is slightly undervalued; the Japanese yen seems to be spot-on. For the first time, we have included India in our survey. McDonald’s does not sell Big Macs there, so we have taken the price of a Maharaja Mac, made with chicken instead of beef. Meat accounts for less than 10% of a burger’s total cost, so this is unlikely to distort results hugely. It indicates that the rupee is 53% undervalued.

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