What is the Big Mac Index and Why is it Important?
The Big Mac index is an indicator used to compare the cost of living in different regions of the world. This index calculates the purchasing power of the currencies of those countries based on the prices of the same product, the Big Mac hamburger, in different countries. Thus, it is possible to see which countries' currencies are overvalued or undervalued.
The Big Mac index was introduced by the British economic magazine The Economist in 1986. The magazine explained the reason for choosing the Big Mac hamburger as follows: "Big Mac is a standard product sold almost everywhere in the world. The ingredients in the Big Mac (meat, bread, cheese, lettuce, onion, pickles, sauce) are available in every country and "They are inputs whose prices can be easily tracked. Additionally, the price of a Big Mac also reflects factors such as that country's labor cost, taxes, and rent expenses."
How is the Big Mac index calculated? First, the price of a Big Mac in each country is converted to dollars. Then, these prices are divided by the price of a Big Mac in the US. These rates give the purchasing power parity (PPP) of that country's currency against the dollar. PPP refers to the exchange rate at which a basket of goods or services can be purchased at equal prices between two countries. For example, in July 2021, while a Big Mac was 25 TL in Turkey, it was 5.65 dollars in the USA. In this case, Turkey's PPP is calculated as 25/5.65 = 4.42 TL/dollar.
What does the Big Mac index do? This index shows how close that country's official exchange rate is to the PPP. If the official exchange rate is higher than the PPP (i.e. one dollar buys more TL), then the TL is overvalued. If the official exchange rate is lower than the PPP (i.e. one dollar buys less TL), then the TL is overvalued. For example, Turkey's official exchange rate in July 2021 was 8.64 TL/dollar. In this case, it can be said that TL is extremely undervalued.
Why is the Big Mac index important? This index can be used to reveal imbalances in the global economy. Overvalued or undervalued currencies can lead to problems such as trade deficits, inflation, and competitiveness. Central banks or governments may intervene to solve these problems. For example, policies such as increasing interest rates or using foreign exchange reserves can be implemented to evaluate TL, which is an extremely undervalued currency.
Is the Big Mac index a perfect indicator? Of course no. This index is very simple and limited as it is calculated only on a single product. The basket of goods and services consumed in each country is different. There are also local factors that affect the price of the Big Mac. For example, in some countries the Big Mac may be perceived as a more popular or luxury product. Therefore, the Big Mac index alone is not a sufficient indicator. However, when used in conjunction with other data, it can be a useful tool for economic analysis.