On the origins of the hamburger standard

By C.R.

In this week's print edition, we present the latest update of our Big Mac index, invented by The Economist in 1986 as a lighthearted guide to whether currencies are at their “correct” level. It 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. For example, the average price of a Big Mac in America in January 2015 was $4.79; in China it was only $2.77 at market exchange rates. So the "raw" Big Mac index says that the yuan was undervalued by 42% at that time.

Burgernomics 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. Historical data for the Big Mac index is available here. And below we reproduce our article introducing the index from 1986.

On the hamburger standard

Sept 6th 1986

Golden Arches

Depressing though it may be to gourmets, the “Big Mac” hamburger sold by McDonald’s could well oust the basket of currencies as an international monetary standard. After all, it is sold in 41 countries, with only the most trivial changes of recipe. That ought to say something about comparative prices. Think of the hamburger as a medium-rare guide to whether currencies are trading at the right exchange rates.

Big-Mac-watchers will rely on the theory of purchasing-power parity (PPP) for currencies. This argues that an exchange rate between two currencies is in equilibrium (ie. at PPP) when it equates the prices of a basket of goods and services in both countries—or, in this case, that rate of exchange which leaves hamburgers costing the same in each country. Comparing actual exchange rates with PPPs is one indication of whether a currency is under- or over-valued.

The Economist’s correspondents around the world have been gorging themselves in a bid to test Mac-PPPs. In Washington, a Big Mac costs $1.60; in Tokyo, our Makdonarudo correspondent had to fork out Y370 ($2.40). Dividing the yen price by the dollar price yields a Mac-PPP of $1=Y231; but on September 1^st, the dollars actual exchange rate stood at Y154. The same method gives a Mac-PPP against the D-mark of DM2.02. Conclusion: on Mac-PPP grounds, the dollar looks undervalued against the yen and the D-mark.

Sterling is different, The Mac-PPP for the pound is $1.45 (69p to the dollar), within a whisker of the actual rate of around $1.49. But the pound’s Mac-PPP against the D-mark is DM3.86, suggesting that sterling is undervalued at DM3.02. British industrialists, who squeal about the pound’s current “strength”, will now like hamburgers even less.

The Australian dollar appears to have been heavily oversold; it is 34% below its Mac-PPP rate against the American dollar. Meanwhile, the Irish pound appears to be spot on. However, our correspondent in Ireland has uncovered an opportunity for arbitrage. This month, a Big Mac can be enjoyed in Dublin for just 20 tokens from milk cartoons.

The hamburger standard provides the United States with strong evidence for its contention that Asian NICs (newly industrialising countries) ought to upvalue their currencies; they are more or less tied to the dollar, so their exchange rates have barley budged during the past 18 months. A hamburger costs 64% more in Washington than in Hong Kong—ie, on Mac-PPP grounds the dollar is 64% over-valued against the Hong Kong dollar. It is also 23% too high against the Singapore dollar.

Caveat hamburger

The hamburger standard has its limitations. Using purchasing-power parities to forecast movements in exchange rates can produce misleading results. For instance, price differences between countries can be distorted by taxes, transport costs, property costs or such things as the famously high retail mark-ups in Japan and West Germany.

A more serious objection is that a PPP simply indicates where exchange rates should be in the long run if price levels were the only difference between countries. In fact, there are many other differences. So even though PPPs are handy for converting living standards (GDP per person) into a common currency, there are not necessarily the best way to judge the exchange rate needed to bring the current account of the balance of payments into “equilibrium”. Confused? Some economics can be hard to digest.