Recall that what the Economist did was take the concept of purchasing power parity and make it, well, palatable. The concept is that a basket of tradable should sell for the same price in different countries. To the extent they do not, a misalignment in the foreign exchange market seen.
Of course, there cannot be current adjustments within the euro area, a fixed exchange rate zone. Instead, the divergence in the price of Big Macs reflects the divergence in competitiveness.
The fact that Big Mac’s in Germany have risen more than the euro area average may be the most important observation from the chart. To the extent that this means that Germany is experiencing somewhat greater than average inflation, is a favorable development for reducing the region’s imbalances. Falling unit labor costs in the periphery is helpful to restore competitiveness, but slightly higher German inflation would also help the adjustment process. It does so without putting more pressure on the clearly fragile political climate in much of the periphery.
The fact that the price of Big Mac’s in Italy have risen more than average (within the euro area) is problematic. However, it is consistent with what we have seen in unit labor costs and productivity. Italy appears to be moving in the wrong direction. It suggests that regardless of the electoral outcome in a couple of week, the next government faces serious competitive challenges.
This piece is cross-posted from Marc to Market with permission.