What does the Big Mac say about Euro Area adjustment?

By Guntram B. Wolff on 6th February 2013

The Big Mac Index offers some quick insights into the state of currencies around the globe by comparing the price of Big Macs across countries. Of course, the Big Mac index was never intended as a precise gauge of currency misalignment, as the Economist has just reminded us in its latest update. According to them, it is just about making PPP and other difficult exchange rate concepts more digestible.

Well, in the euro area, we have the euro to be able to simply compare prices across the euro area. So how have Burger prices moved recently? Are prices in the euro area adjusting? Should we be pessimists or optimists on the adjustment challenge in the euro area? Since July 2011, the Economist has also been collecting the individual prices of Big Macs in major euro area countries. Let’s first look how they have developed in the different countries relative to the euro area average:

Source: Bruegel computation based on data compiled by the Economist.

I’d say, there are some good news here. Austria and Germany grow above average, while Greece, Ireland, Portugal and Spain are below average. Even France is below average. So adjustment seems to be working not just for unit labour costs but even real prices adjust[1].

However, not all appears to be rosy. Burger prices in Italy have increased much more than anywhere else except for Estonia. But perhaps Italy is just catching up? Let’s look at the levels:

In fact, the Big Mac tells us that Italy is the most expensive place in the euro area. A Big Mac costs €3.85, while it costs only €3.6 in France and 3.64 in Germany. Or to put it in percentages, in July 2011, Italy was overvalued by 2.9% while in January 2013, it was overvalued by 5.7% relative to Germany. Of course, you may just as well say that Germany was undervalued… but then, the adjustment in Germany seems to go in the right direction but not in Italy in these last one and a half years.

Of course, one may argue that the Big Mac is a very special kind of food in the land of Pasta & Chianti. And of course, there has been quite some reporting last year that Italians are reducing their spending on food. So are Big Mac prices special because Italians substitute high end food with BigMacs? A quick look at a broader set of prices, namely the harmonized consumer price index, show that this is not a special Big Mac story. Italy had the highest inflation in the euro area from July 2011 to end of December 2012: prices were rising by more than 6%, while in the euro area they were increasing by only 3.9%. Well, perhaps all we capture are the tax increases that Italy put in place to adjust its public finance trajectory? A quick look at the HICP at constant taxes published by Eurostat again puts Italy at the top of the league with an increase of 4.8% during July 2011- November 2012 (the latest month with available data), while the euro area just increased by 2.9%. To be fair, HICP inflation in Germany undercuts the euro area rates – the Big Mac index doesn’t fully capture the missing price adjustment in Germany.

Overall, the Big Mac index shows some adjustment in the euro area in the last 18 months but Italian inflation rates are worrying. Labour market reforms that do not translate into lower product market prices are detrimental to consumers and prevent the economy from gaining export strength. Italy needs to apply the right policies to address high inflation.

[1] On the link between ULC and CPI, see Guntram Wolff, Arithmetics is absolute, Bruegel Policy Contribution.

Comments

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  • afauno 6th February 2013

    Are you serious with this? Did you background check things like VAT rates on food, fat taxes, price of meat... Your big mac prices may be no more than the composite result of a few sparse factors, you can\'t expect them to reveal deep trends of the eurozone because a SINGLE product doesn\'t make a reliable sample. Of course one thing it does is making hasty conclusions vivid and understandable for dummy readers, perhaps that\'s what this article was going after ?

    Reply to afauno

    • Guntram Wolff 6th February 2013

      @ afauno: thank you for your comment. In the second to last paragraph I look at the HICP adjusted for tax changes. And Italy is still experiencing the highes inflation rates. On the single product, I agree: that is why I also provide the HICP evidence.

  • Ellen 6th February 2013

    which would then be \'right policies to address high inflation\'? We are next to election days and we, or at least myself, I would be very appreciate some suggestions, from outside Italy* and from outside the fake and polemical chitchatting of these weeks. Thanks E V *(we still have Berlu, but also Renzi, Bersani, Bonino, and even Monti.... or an apparently weird man but quite brave O. Giannino)

    Reply to Ellen

  • Edvin Granroth 7th February 2013

    In the first figure on relative price changes Italy is apprently in \"wrong company\" when among Austria, Estonia, Germany, and Netherlands. However Finland, a triple A-country, is in the same figure among crisis countries Ireland, Portugal, and Spain as well as still teetering France and Belgium. Could you provide some insight why Finland is among those contries in which the relative price of Big Mac has declines?

    Reply to Edvin Granroth

  • Edvin.Granroth 7th February 2013

    Further question. I looked at HICP data at Eurostat. I am not convinced it is a valid explanation for the somewhat odd behavior of Finnish Big Mac prices. As Finland (still) is a triple.A economy it seems to sit in wrong company. As you mentioned \"the Big Mac index doesn’t fully capture the missing price adjustment in Germany\", either.

    Reply to Edvin.Granroth

  • lucu 7th February 2013

    Finnish prices reflect the \"true\" state of the country\'s economy. The Finnish way of \"cooking the books\" is just a way lot smarter than the Greek or Italian hence triple A rating for an economy that is nearly bust.

    Reply to lucu

  • Pieter Mathieux 7th February 2013

    The worst thing about the big mac index, is that third world countries try to manipulate the index. Argentina freezed the prize of a Big Mac, so that the inflation would not appear so high as it is now. (A Cheeseburger in Argentina is much ,ore expensive as a Big mac nowadays)

    Reply to Pieter Mathieux

  • Ernest Payne 7th February 2013

    Thank you for the article. It appears as though the author, like an economist friend, has his feet firmly planted in the real world.

    Reply to Ernest Payne