The Big Mac purchasing power parity is a novel way to measure the accuracy of currency rates that was created by the Economist. The basic idea behind the PPP is that, after exchanging currencies, the price of identical goods in different countries should be equal. This means that a coffee at Starbucks in Canada should cost the same amount in USD after conversion as it does in America. If it is cheaper to buy a coffee in Canada, then the Canadian dollar is undervalued (or the USD overvalued). The Big Mac PPP uses a McDonald’s Big Mac as the benchmark good because it is widely available.
The Big Mac PPP is a good measure for people investing in the forex markets. The only problem is that governments often hamper the efficiency of the market. For example, China has historically kept the Yuan artificially undervalued to make Chinese goods much cheaper than goods produced in other countries. The Yuan will continue to linger behind other currencies in PPP until the government floats it freely. So forex investor have to watch the government’s policies as carefully as the Big Mac PPP in order to accurately forecast a change.
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