Big Mac Index Explained: How A Burger Measures Economic Health

Key Takeaways

• The Big Mac Index offers a simple and informal way to gauge whether currencies are overvalued or undervalued relative to the US dollar based on the price of a Big Mac burger.
• The Big Mac Index provides a snapshot of PPP and can highlight differences in cost of living across countries, but should be used alongside other economic indicators for a comprehensive view.
• The index simplifies complex economic conditions and does not account for all factors influencing exchange rates, such as interest rates and geopolitical events.
• The Big Mac Index is not designed to predict cryptocurrency values or macroeconomic impacts on digital assets, as it focuses on traditional fiat currencies.

What Is The Big Mac Index?

The Big Mac Index was introduced by The Economist magazine in 1986 and is an informal measure of purchasing power parity (PPP) between different currencies. 

The Economist magazine first presented it as a method of determining if a currency is overpriced or undervalued in relation to the US dollar using the cost of McDonald’s Big Mac burger (a benchmark). 

As of July 2024, with a Big Mac costing £4.59 in Britain and $5.69 in the U.S., the implied exchange rate is 0.81. Since the actual exchange rate is 0.78, the British pound is about 3.6% overvalued .

According to the January 2024 Big Mac Index , Switzerland has the highest Big Mac price globally at $8.17. In comparison, a Big Mac costs $5.69 in the U.S. and $5.87 in the Euro area.

Brief History

• 2000s: The index became well-liked and extensively used as a humorous yet perceptive method of comparing currency values between nations.
• 2010s and later: It evolved to incorporate new features such as information on regional price variations and cross-national currency comparisons.

Purpose

• Economic insight: It provides a humorous yet helpful approach to comprehending inflationary pressures and economic situations beyond national boundaries. In addition to highlighting differences in cost of living, the index can shed light on current market and economic circumstances.
• Currency valuation: The Big Mac’s price across nations can be compared to get a quick idea of how well exchange rates match the principle of purchasing power parity.
• Accessibility: Using a widely recognized product, the Big Mac Index is accessible to a wider audience than complex economic models. It enables individuals to connect economic theory to a well-known product.

U.S. Economic Conditions And The Big Mac Index: Is The United States In A Recession?

The United States is not in a recession, according to the current economic indicators, but growth is slower. In the second quarter of 2024, the real GDP rose at a pace of 2.8%, up from 1.4% in the first quarter (BEA ). Forecasts from a number of sources, however, point to a more cautious picture for the next few years, with further decreasing growth anticipated.

Although it has been high, consumer spending — a major factor in economic growth — is predicted to decline. Going forward, consumer spending is probably going to be restrained  by rising interest rates and the depletion of excess savings from the pandemic, according to Deloitte.

Furthermore, there has been a slight decrease in the Leading Economic Index (LEI), indicating that the economy may have difficulties in sustaining its present growth trajectory (The Conference Board ). This situation calls for close observation of impending economic data releases and changes to policy.

However, it is evident that the Big Mac Index is not a direct indicator of a recession as it is tied to a single product, whereas when the economy experiences a recession, there is usually a noticeable drop in economic activity that lasts more than a few months. 

This reduction is frequently evident in real GDP, real income, employment, industrial production, and wholesale-retail sales. The Big Mac Index does not specifically show if a nation like the USA is experiencing a recession; rather, it highlights economic circumstances or currency values.

How The Big Mac Index Works

Often associated with “Burgernomics,” this concept goes beyond just currency valuation. It provides a humorous yet revealing look at global price levels and inflation trends by comparing the cost of a Big Mac in various countries.

This section explains how the Big Mac Index works, including its calculation methodology, its relationship to PPP:

Currency Conversion And Purchasing Power Parity (PPP)

PPP is a way of comparing the cost of living between different countries. It simply measures how much a standard set of goods and services — like a basket of groceries — costs in other places or countries.

Calculation Methodology

• Collect prices: The Economist collects the cost of a Big Mac in different nations, usually in local currency. They frequently use the cost of a regular Big Mac instead of regional differences for consistency.
• Convert prices: The Economist uses the current exchange rate to convert the local prices into US dollars to compare these prices. For instance, the price of a Big Mac in dollars would be 5 * 1.10 = $5.50 if it were to cost 5 euros in France, and the current exchange rate was 1 euro = 1.10 dollars.
• Price comparison: The converted amount contrasts the cost of a Big Mac in the United States. For example, if the price of a Big Mac in France is $5.50 and it costs $5 in the United States, then the Big Mac Index would suggest that the euro is overvalued by 10% (5.50 – 5 / 5).

The Big Mac Index Vs. Economic Indicators

The Big Mac Index works best when used alongside other economic indicators. Let’s understand its correlation with other economic indicators:

Purchasing Power Parity (PPP)

• Direct relation: The Big Mac Index provides a snapshot of PPP-based currency valuation and is, hence, directly correlated with the PPP.

Inflation Rates

• Indirect influence: Inflation can affect the price of Big Mac in home country i.e,higher inflation means consumers pay more for the Big Mac in local currency. A comparison between the official inflation rates and the index can provide better insights on a currency’s movement with broader economic trends.

Exchange Rates

• Direct relation: Exchange rates are directly used by the Big Mac Index to translate local Big Mac pricing into US dollars. It illustrates whether the value of a currency is higher or lower than what PPP, which is based on Big Mac prices, would imply.

Interest Rates

• Indirect influence: Inflation and exchange rates are influenced by interest rates. Although interest rates are not directly measured by the Big Mac Index, they can have an indirect impact on the currency values and overall state of the economy that the index is indirectly reflecting.

Economic Growth

• Indirect influence: Strong economic expansion may result in elevated prices and earnings, thus driving up the price of a Big Mac. It is possible to determine whether changes in the value of a currency are compatible with economic performance by comparing the index with data on economic growth.

Cost Of Living And Consumer Price Index (CPI)

• Indirect relation: There is a correlation between the CPI and other cost of living indicators and the Big Mac Index. The index may offer more context for comprehending local pricing levels if it indicates that a currency is overpriced or undervalued in relation to the CPI.

Can The Big Mac Index Apply To Crypto?

The Big Mac Index is used to compare currency values based on the cost of a Big Mac across different countries, but it could offer insights about the state of the cryptocurrency market.

The Big Mac Index Vs. Cryptocurrencies

It might be possible to utilize the Big Mac Index to evaluate the worth of cryptocurrencies in relation to fiat money. You may be able to learn more about how cryptocurrencies are valued in relation to fiat currencies during a market downturn, for instance, by keeping track of the price of a Big Mac in terms of Bitcoin (BTC) or another cryptocurrency.

You may gauge changes in a cryptocurrency’s purchasing power by converting the price of a Big Mac into cryptocurrency using the Big Mac Index. This can provide a distinct viewpoint on whether the practical value of a cryptocurrency is increasing or decreasing. 

Suppose the price of a Big Mac increases dramatically in terms of cryptocurrency during a market downturn. In that case, it may be a warning that cryptocurrency is depreciating in terms of real-world goods. 

On the other hand, if the value of the cryptocurrency increases or stays the same in comparison to these things, it may indicate better performance or perceived stability. 

Potential Implications For Cryptocurrency Investors

• Market trends: Assists in understanding cryptocurrency performance against traditional economic indicators.
• Valuation insights: Helps investors gauge cryptocurrency value relative to real-world goods.
• Risk management: Aids in portfolio diversification and risk assessment during economic downturns.

Criticisms And Limitations Of The Big Mac Index

While the Big Mac Index offers a fun and accessible way to look at currency valuation and purchasing power, it should be used with an understanding of below criticisms and limitations:

• Simplification of complex economies: It oversimplifies the diverse factors affecting currency value by comparing complex economic conditions to a single product.
• Exclusion of non-traditional assets: Ignores assets like cryptocurrencies and commodities that may influence economic conditions and currency valuations.
• Cultural differences: Assumes uniform production quality and demand for a Big Mac, ignoring geographical and cultural differences in consumer tastes as well as economic considerations.
• Local variations: Due to regional supply chain networks, cost structures, and economic factors that do not accurately reflect national economic reality, the price of a Big Mac can vary dramatically.
• Short-term fluctuations: Short-term exchange rate movements can distort the index’s effectiveness in indicating true currency valuation.

Conclusion

The Big Mac Index provides a unique yet insightful look into currency valuation by comparing the cost of a standardized product — the Big Mac— across different countries. It serves as an informal measure of PPP, illustrating whether currencies are overvalued or undervalued against the US dollar. 

Although it offers a humorous and accessible perspective on economic conditions and currency values, it simplifies complex economic realities. It may not fully capture regional variations or non-traditional assets like cryptocurrencies. 

The Big Mac Index should be used alongside other economic indicators and analyses for a comprehensive understanding of currency and economic health.

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About the Author

Alisha Bains

Alisha is a versatile professional with a strong background in digital finance backed by multiple certifications. In 2016, she started working with DeFi projects. Alisha has since held various roles, including analyst, researcher, and project manager, in the cryptocurrency and blockchain space. Her contributions extend widely within the industry. Alisha has  contributed to newsletters and research reports. Beyond her professional endeavors, Alisha is a passionate traveler who embraces diverse cultures. She frequently engages in outdoor activities such as hiking and trekking, finding solace in the natural world, which complements her enthusiasm for the dynamic landscape of blockchain technology.

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