Latin American currencies have depreciated but are not as undervalued as in 2002

The Economist regularly updates the so called the Big Mac index. The magazine uses McDonalds’ Big Mac hamburger of because it is a good that is relatively homogeneous internationally and hence may be used to assess the law of one price.

Panel A shows the price of the hamburger in Brazil and in the US. Panel B shows the parity exchange rate (the price of the hamburger in Brazil divided by the price in the US) and compares it with the spot exchange rate. Panel C shows the degree of appreciation or depreciation of the Brazilian real (how the spot exchange rate compares with the parity exchange rate in percent), and of other Latin American currencies. Panel D shows the degree of exchange-rate appreciation or depreciation of countries in different regions.

The difference between the spot and parity exchange rates is related to income. Developed-country currencies appear appreciated while developing-country currencies appear depreciated (Panel D). This is due to the fact that prices tend to be higher in developed countries. The price of a hamburger may be higher in the US because salaries in a US McDonalds compete with salaries in the US tradable sector which is presumably more productive than the tradable sector in Brazil. In turn, salaries in a Brazilian McDonalds compete with those in the Brazilian tradable sector. This is the Balassa-Samuelson effect. Higher salaries in the US mean higher prices than in Brazil.

The consequence of the Balassa-Samuelson effect is that in advanced (developing) economies spot exchange rates look appreciated (depreciated) relative to the parity exchange rates.

Assuming that this consequence of the Balassa-Samuelson effect on the parity exchange rates does not change over time, it is possible to analyze the time path of the extent of exchange rate overvaluation or undervaluation relative to The Economist’s benchmark. Panel C reveals that, compared to the benchmark, the Brazilian real was most undervalued in 2002 when global risk aversion rose. Since then, it has appreciated strongly. The Brazilian real has depreciated somewhat since the start of the global financial crisis; nonetheless, it is still not as undervalued as it was in 2002.

The currencies of emerging European countries appreciated during the rise in “irrational exuberance” that took place during much of the first decade and have depreciated since the start of the global financial crisis. In Asia currencies do not seem to have appreciated or depreciated much relative to the benchmark. In Latin America, currencies depreciated until 2002, started appreciating after that and have depreciated again starting with the global financial crisis. However, Latin American currencies are still not as undervalued as they were in 2002.

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3 Responses to "Latin American currencies have depreciated but are not as undervalued as in 2002"

  1. sage   February 25, 2009 at 3:56 pm

    agreed 100%, as a matter of fact they may have or be reaching their trade weighted optimum levels.

  2. RGBx   February 27, 2009 at 2:09 pm

    Wow. What a good comparison. Just the mere fact that Micky’Ds is such an economic power scares the bejeezes out of me. Whatever happened to the milk index? There has to be some kind of parallel universe going here. Fat and Diabetes (ooh, economics baby) or healthy an a dose of vitamin D.Somehow we have to choose. Get a diet, world.

  3. Anonymous   February 28, 2009 at 2:25 pm

    I think this comentary is very important but is very simple end this commentary may to special case, for exemple, economy govern, economy social, about de Bank, great firm, the situations this firms, becouse I stay in Brazil end the notice is very bad for our economy