Introduction to the Big Mac Index
The Economist introduced its latest Big Mac Index on July 16, a tool that simplifies the theory of exchange rates. It compares major global currencies and their value against the US dollar, using McDonald’s iconic Big Mac as a benchmark priced at $6.01 in the United States.
Big Mac Index Findings
According to the index, Switzerland, Uruguay, and Norway have the strongest currencies relative to the US dollar. In Latin America, Colombia ranks tenth with the most expensive Big Mac, indicating a 5.2% devaluation of the Colombian peso compared to the US dollar.
Currency Valuation
The Swiss franc leads the list with a 49.6% appreciation against the US dollar, based on the $6.01 Big Mac reference price. Approximately 0.81 Swiss francs equal one US dollar, making the local currency stronger than the dollar and providing greater purchasing power for the same burger.
Conversely, Egypt has the most devalued currency, with the Egyptian pound depreciating 57.9% against the US dollar. A $6.01 Big Mac costs 296.97 Egyptian pounds in Cairo, with currency exchange rates offering 49 Egyptian pounds per US dollar.
Colombia’s Case
Colombia’s peso devaluation stands at 5.2% compared to the US dollar, meaning one US dollar is worth 4,016.44 Colombian pesos. Consequently, a $6.01 Big Mac costs 24,138 Colombian pesos, reflecting the exchange rate and purchasing power of the local currency.
The Theory Behind the Big Mac Index
The Economist explains that the index aims to demonstrate “distortion in exchange rates,” suggesting currencies should ideally have parity in purchasing power. The Big Mac serves as a global benchmark for comparing currency disparities, being consistent across countries except in Israel and India where it’s served without cheese or with chicken instead of beef.
Expert Opinion
Alejandro Espitia, a macroeconomics professor at Colombia’s Universidad Javeriana, states that The Economist’s measurement was created in 1986 as a good indicator for analyzing purchasing power parity. While not official, it’s considered a reliable reference to gauge a country’s cost of living or currency affordability. It evaluates exchange rate imbalances and market competitiveness.
Investors can use the index to determine how many units of goods they can acquire and if production will become cheaper in a country. However, the index has limitations as it doesn’t account for trade barriers, labor laws, and other factors influencing currency changes. It assumes the Big Mac represents a country’s general economic situation.
President Trump and Trade Policies
The Economist acknowledges it’s challenging to assess the impact of tariffs and trade policies by merely examining Big Macs. Nevertheless, one significant issue President Trump aims to address through his tariffs is trade surpluses, believing certain countries manipulate their currencies to artificially lower export prices.
There’s a contradiction in US policies, as Treasury Secretary Scott Bessen claimed tariffs would strengthen the dollar by offsetting tax impacts, while investor confidence in Washington’s policies weakened, causing dollar depreciation. The result is higher taxes and a weaker US currency for imported goods, as stated in the report.
The Economist Defends its Currency Index
The Economist asserts that the Big Mac Index serves as a “practical guide” to determine if currencies are at their “correct” levels. Although it wasn’t intended as a precise monetary misalignment indicator, the index simplifies concepts about exchange rates and purchasing power.
The Big Mac Index has become a global standard, incorporated into numerous economics textbooks and subject to dozens of academic studies, according to The Economist.
Key Questions and Answers
- What is the Big Mac Index? The Big Mac Index is a simplified tool by The Economist to understand exchange rates, comparing the price of a Big Mac in various countries to its US baseline price.
- Who created the Big Mac Index? The index was introduced by The Economist in 1986 as a tool to analyze purchasing power parity.
- What are the limitations of the Big Mac Index? The index doesn’t account for trade barriers, labor laws, or other factors influencing currency changes and assumes the Big Mac represents a country’s general economic situation.
- How does the Big Mac Index relate to President Trump’s trade policies? The index can help assess the impact of tariffs on imported goods’ prices, though it doesn’t directly measure trade policy effectiveness.
