Working Paper: NBER ID: w5675
Authors: Robert E. Cumby
Abstract: A decade ago the Economist began an annual survey of Big Mac prices as a guide to whether currencies are trading at the right exchange rates. This paper asks how well the hamburger standard has performed. Although average deviations from absolute Big Mac parity are large for several currencies, once estimates of these average deviations are removed from the data, the evidence suggests that convergence to relative Big Mac parity is quite rapid. The half-life of deviations from Big Mac parity appear to be about 1 year, which is considerably shorter than estimates of the half-life of deviations from purchasing power parity (4-5 years) that are reported in the literature. In addition, deviations from relative Big Mac parity appear to provide useful information for forecasting exchange rates. After accounting for currency-specific constants, a 10 percent undervaluation according to the hamburger standard in one year is associated with a 3.5 percent appreciation over the following year. Finally, deviations from relative Big Mac parity seem to be helpful in forecasting relative local currency prices. When the U.S. dollar price of Big Macs is high in a country, the relative local currency price of Big Macs in that country is likely to fall during the following year.
Keywords: Exchange Rates; Big Mac Index; Forecasting; Purchasing Power Parity
JEL Codes: F31; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| deviations from Big Mac parity (F31) | future exchange rates (F31) |
| deviations from Big Mac parity (F31) | local prices (P22) |
| 10% undervaluation (Big Mac) (F31) | 35% appreciation (exchange rate) (F31) |
| high US dollar price of Big Macs (F31) | low relative local currency price of Big Macs (F31) |
| historical deviations return to parity (F31) | future exchange rates (F31) |