The Economist invented the Big Mac Index in 1986 to check currency valuations. It serves as a humerous way to digest (pun intended) exchange-rate theory. The index is based on the theory of purchasing-power parity (PPP). In the long run, countries' exchange rates should move towards rates that would equalise the prices of an identical basket of goods and services. The Economist’s basket included one good, the McDonald's Big Mac, produced in 120 countries. The Big Mac purchasing power parity (PPP) is the exchange rate that would leave hamburgers costing the same in America as elsewhere. Comparing these with actual rates signals if a currency is under- or overvalued.
When I first discovered the index as an undergraduate economics major, my first instinct was to participate in burger arbitrage. More recently I have thought that the Big Mac Index is a bit out of touch with the eating habits of some consumers—namely me. In fact, I cannot remember the last time I had a Big Mac.
On recent trips to South-east Asia, Europe, and South America, however, I have enjoyed a Starbuck’s latte (or two – they are addicting!!) and I couldn’t help but wonder whether a “Latte-Index” would be a better measure for the Economist.
It appears that I should be reading the Economist a bit closer (my dog ate my most recent addition — seriously, I can show you the scraps). They have been running a “tall-latte index” since 2004 and it seems that the “latte index” broadly tells the same story as the Big Mac index for most main currencies.
Tim Harford on the “tall-latte index”