International Monetary Economics Term Paper

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International Monetary Econ

The price of a Big Mac varies around the world, and has been used (albeit not seriously) as a means of testing currency exchange rate parity. The prices of a Big Mac around the world are gathered in the Big Mac Index found on Oanda. The price of a Big Mac in U.S. dollar terms using current spot rates and July 28, 2011 Big Mac prices are as follows:

Country

Local Price

USD Price

USA

China

¥14.7

Brazil

R$9.50

Germany

€3.44

India

Japan

¥320

Russia

p

Switzerland

To calculate the predicted exchange rate, the local currency price should be divided by dollars. Thus the exchange rate implied by the price of a Big Mac is as follows:

Country

Implied Exchange Rate

USA

1.000

China

3.612

Brazil

Germany

0.8452

India

20.6388

Japan

78.624

Russia

1.658

Switzerland

1.597

According to the Big Mac parity theory, currencies whose values diverge from their Big Mac Index should move towards parity.

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Country

Value?

USA

Brazil

Overvalued

China

Undervalued

Germany

Overvalued

India

Undervalue

Japan

Slightly overvalued

Russia

Undervalued

Switzerland

Overvalued

4. The Big Mac parity theory holds that these currencies should move back towards parity from their current positions. If we look at them individually, we can see some unique cases. The real is overvalued, and therefore should be expected to lose value against the dollar in the coming year. The yuan is undervalued, something that is common knowledge, but while it is expected to increase in value vs. The dollar in the coming year it will not move to parity. The yuan is not freely floating, so it will only move as far as the Chinese government will let it. The euro is overvalued according to the Big Mac theory. It is declining in value, but not because of any currency parity. The euro….....

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