The Big Mac Index
The Big Mac Index is an informal way of measuring the purchasing power of different currencies in the global economic system. First published by The Economist in 1986, the index is based on the idea of comparing the prices of a McDonald’s Big Mac in different countries. If a Big Mac costs more in Country X than in Country Y, it suggests that the currency of Country X is less valuable than the currency of Country Y.
The Big Mac Index gives us useful insights into the strength of different currencies and the changes in purchasing power between countries over time. It can also be used as an indicator of inflation, which is the term used to describe the rate at which the prices of goods and services increase over time.
What is Inflation?
Inflation simply means increasing prices over time. It is usually measured using the Consumer Price Index (CPI), which tracks the prices of a selection of commonly used goods and services. The rate of inflation represents the percentage increase in consumer goods prices over a period of time.
When the price of consumer goods increases, this usually indicates that the currency being used is being devalued. That is to say, goods in a particular currency become more expensive relative to other goods, which in turn means that goods priced in other currencies are becoming more attractive by comparison.
When inflation is high, goods and services in the country become more expensive and it takes more of the local currency to buy the same goods and services. This has an impact on both macro and micro economics, as purchasing power reflects the value of money used both in large scale transactions and in everyday purchases.
Inflation and Big Mac Index
Inflation affects the Big Mac Index as the index is based upon the cost of goods in different currencies comparing to the cost of a Big Mac. When the prices of goods increase, the cost of a Big Mac will also increase. As a result, the price of a Big Mac will no longer be a reliable indication of the purchasing power of different currencies.
When inflation is high, the cost of a Big Mac will increase disproportionately to the cost of other goods and services in the country. This is because the cost of a Big Mac is predominantly driven by labour and ingredients, and these costs are more sensitive to inflation than other goods and services are.
In particular, inflation affects the index when interest rates are distorted. This is because interest rates are a major determinant of inflation and as such, they will have an influence on the relative prices of goods in different currencies. When interest rates remain low for too long, it can cause prices of goods to increase faster than the cost of labour, causing the a Big Mac index to become less reliable.
For example, if the interest rate in the country is kept lower than the inflation rate, the prices of goods will increase faster than wages. This will affect the cost of McDonald’s Big Macs as the cost of labour and ingredients will increase, even though wages may not necessarily be rising as quickly.
Impact of Inflation on the Big Mac index
Inflation has a direct impact on the Big Mac index as it affects the price of goods in different currencies. When inflation is high and prices of goods increase disproportionately, the index may no longer be an accurate representation of purchasing power between different countries.
Furthermore, the long-term impacts of inflation can also be difficult to measure when using the Big Mac index. For example, if inflation is kept low for too long, it may lead to a false impression of economic stability and security, but this is often not reflected in the index.
The Big Mac index is a useful tool for measuring the purchasing power of different currencies in the global economy. However, it is affected by inflation and should not be used as a reliable indicator of inflation or economic stability in the long-term.
