Latest Big Mac Index indicates an undervalued Czech crown

Despite recent strength, the Czech crown continues to show signs of undervaluation according to the latest Big Mac index. While the crown has gained ground against foreign currencies this year, the price of a McDonald's Big Mac burger remains indicative of an underlying undervaluation.

The Big Mac Index is a playful yet informative gauge produced by The Economist twice per year since 1986. According to the latest Index, published this month, a Big Mac costs $5.58 (about CZK 123) in the United States, and is priced at CZK 105 ($4.78) in the Czech Republic.

By this measure, the exchange rate should theoretically stand at CZK 18.82 per dollar. However, as of the end of July, it was weaker at CZK 21.65 per dollar. This indicates that the Czech crown is currently undervalued by 13 percent against the US dollar.

The crown is even more undervalued against the euro. Comparing Big Mac prices in eurozone countries where the euro is used, the Czech crown is found to be undervalued by nearly 17 percent, signifying a significant difference in purchasing power.

The Big Mac Index calculates the implied exchange rates of currencies based on the local prices of the McDonald's Big Mac hamburger across different countries. While it's a simplistic approach, it offers insights into whether a currency is overvalued or undervalued in comparison to the US dollar.

Critics of the index highlight that it doesn't consider factors such as labor costs and local economic conditions that can significantly affect prices. In response, a modified version of the index was introduced in 2011, incorporating GDP per capita as a measure of labor costs.

The Czech crown's undervaluation is less pronounced when considering the GDP-adjusted version of the index. This alternative measure suggests that against the dollar, the crown is undervalued by only 1.8 percent as of July. Against the euro, the undervaluation narrows to 15 percent, compared to the 17 percent seen in the basic version of the index.

A year ago, the index indicated a 23 percent undervaluation of Czech currency against the dollar. However, over the past year, the crown has appreciated around 8 percent against the US dollar due in part to higher interest rates offered by the Czech National Bank.

The price of a Big Mac has increased worldwide over the past year. The recent 10.5 percent year-on-year increase in the price of the Big Mac in the Czech Republic contrasts with an 8.3 percent increase in the United States.

Despite criticisms, the Big Mac Index does provide a tangible way to explore the economic concept of purchasing power parity between countries. Over the years, it has gained recognition as an interesting and informal way to understand currency valuation.