The Big Mac Index: Is It Relevant?
In an article titled “McJobbers and Brokers” Satoshi Kambayashi, a writer from the Economist, argues for the Big Mac Index as a guide to be utilized by currency speculators. The Big Mac Index is a well-known and widely used illustration of purchasing-power parity (PPP), denoting the idea that the value of a currency should reflect its power to buy goods and services.
The tool was invented by the Economist in 1986, “as a lighthearted guide to whether currencies are at their ‘correct’ level” describes the news outlet in its website. Still, it makes sense, the idea is that you can compare PPP by taking a look at the cost of a big mac in different nations and end up calculating what the exchange rate between the two currencies should be.
An example Kambayashi relied on was that of the Hong Kong dollar. This week the monetary officials of the city came out to defend its long-standing peg to the dollar, and while some might interpret it as a move to prop the HK$ up, the contrary is true. Since April, Hong Kong’s monetary authority has had to continually sell HK$ to stop the currency from strengthening too much. This, however, is no news for the Big Mac Index aficionados. In July, it took HK$20.5 to buy a Big Mac, while in the states it took $5. The exchange rate that would then equalize “the burger-buying power” would be HK$ 3.59, a much stronger exchange rate than the current one of HK$7.75.
The reality is that the Big Mac Index is mostly just a bit of fun. But broadly speaking, the results are still in line with sophisticated research. A study by the Universities of Ferrara and Bocconi, showed that trading strategies simply based on PPP could yield good returns, albeit not incredible ones. A Harvard economics professor, on the other hand, pointed out that, in the economic community, PPP was rarely taken seriously in the short term, even if most believe it has some power in the long term. As Kambayashi explained, the Big Mac index and PPP “gives investors something to chew on. But it’s not fast food”.
Kambayashi, S. (2020, September 19). Can you make money from the Big Mac index? Retrieved September 19, 2020, from https://www.economist.com/finance-and-economics/2020/09/19/can-you-make-money-from-the-big-mac-index
The Economist. (2020, July 15). The Big Mac index. Retrieved September 19, 2020, from https://www.economist.com/news/2020/07/15/the-big-mac-index