This post was originally published on July 31, 2013. It was updated on November 11, 2013, August 3, 2014, and again on August 2, 2016 to reflect the new GDP numbers.
Extending our research on the use of the Big Mac Index, as created by The Economist, we applied the rise in the price of a Big Mac in relation to the economy. While Big Mac prices rose over the last three months, the price overall declined in the past 12 months. The burger, as a representation of GDP, may be stealing more than calories from consumers.
The Bureau of Economic Analysis (BEA) reported that in 2015, the economy grew 1.2%. This was far below economists’ expectations reported by Briefing.com. As the BEA indicated in the press release “The increase in real GDP in the second quarter reflected positive contributions from personal consumption expenditures (PCE) and exports that were partly offset by negative contributions from private inventory investments, nonresidential fixed investments, residential fixed investments, and state and local government spending. Imports, which are a subtraction in the calculation of GDP, decreased.”
The deflator used for inflation was up 2.2%, which was far higher than the Consumer Price Index (CPI) of 0.8%. Under estimating inflation results in correspondingly optimistic growth rates. This resulted in the GDP number being significantly higher than it would otherwise be if the CPI was used.
Odds and Ends
The BEA defines gross domestic product, the measure of economic growth as:
GDP = private consumption + gross private investment + government spending + (exports – imports)
Taking it one step further, we can break this down to by private consumption into service and actual goods and investment into fixed investment (machinery) and inventories.
When looking at GDP with all its components, we can see that real final sales was the strongest, but all other components have weakened over the course of the last 12 months. Doug Short graphically represents the components of GDP.
Inflation boosts the growth rate of each of the components of GDP. When the price of food or gasoline increases, GDP increases. This is more accurately called “real” GDP.
Thanks to The Economist, we have come to look at the price of the Big Mac as a good indication of inflation. The Big Mac includes beef, dairy (cheese), wheat (bun), cost of labor, and the cost of real estate. As a result, I believe it is a good representation of inflation.
However, our analysis indicates that the price of the Big Mac has continued to escalate much faster in recent quarters than the official government rate of inflation (CPI-U). Consequently, here is a view of GDP in light of our analysis of prices using the Big Mac Index.
Previously, when including the price of the Big Mac, GDP growth has been exaggerated. We can see that without the benefit of lower inflation, GDP has actually declined by more and for longer lengths of time than the official numbers suggest.
Using inflation (as measured by the Big Mac), we see that growth in GDP is lower than reported by the BEA. The reported 1.2% growth rate fell to a negative 2.0% in the second quarter.
Further, the BEA revised the GDP growth for the first quarter of 2016 from 1.1% down to 0.8%. Might this have been for due to higher inflation? During this time, the GDP deflator rose at an average rate of 0.4% while the Big Mac increased at a rate of 5.0%.
When you compile GDP using the government’s provided consumer price index (CPI), you get divergences both above and below the official figure on GDP.
Richard Davis, the founder of Consumer Indexes, has graphed the differences between the official stated GDP index and GDP compiled with CPI (above). In the four years leading up to July 2016, the divergences using the CPI for inflation have caused the GDP to be higher.
For another look at how GDP is compiled using different “official” rates of inflation, go to Doug Short’s analysis. In his work, Short concludes that using an alternate CPI compiled by Shadowstats was too negative and may significantly understate growth in the economy.
The Real Truth
My conclusion is twofold. First, a large amount of people in the US and around the world rely on Big Macs as sustenance. If this is what they are experiencing in escalating food prices, it should be incorporated into the measure of inflation and GDP growth. Second, financial advisors should be aware of the differences in inflation. When running projections and creating financial plans, they should consider what individuals actually experience for inflation and what the government puts out in the form of CPI-U. They should also be aware that the GDP numbers may not reflect what the consumer experiences. Therefore, financial advisors should understand the differences so that they can help a person plan for his or her retirement rather than have the hamburglar steal a portion of savings.
Study the differences in GDP and learn how to advise your clients in a manner that best prepares them for the changes in the real consumer experience. Stay tuned for updates from AUM in a Box about GDP, inflation and more.
Quarterly GDP dates from 1947; Big Mac Index from The Economist began in 1986, but did not become consistent until Q2 1990. The Economist update Big Mac prices once or twice a year.
Real GDP is quarterly annualized to compare against the annual change in Big Mac prices.
Originally posted at AUM in a Box.
Hamburglar art credit: Rog Hernandez, http://roghernandez.blogspot.com