QCOSTARICA — Costa Rica’s currency, the colon, is ranked sixth out of eight currencies that are considered to be overvalued in comparison to the U.S. dollar, according to the most recent update of The Economist magazine’s Big Mac Index.
The Big Mac Index, invented by The Economist in 1986 as a lighthearted guide, serves as an informal means of assessing whether a currency is overvalued or undervalued.
It is based on the theory of purchasing-power parity (PPP). The methodology involves comparing the price of a Big Mac in different countries and calculating the exchange rate needed for it to be equivalent to the price in the United States.
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According to the most recent report (December 2023), The Costa Rican colon is 0.39% overvalued against the U.S. dollar
From the Economist: “A Big Mac costs ¢2,950 colones in Costa Rica and US$5.69 in the United States. The implied exchange rate is ¢518.45. The difference between this and the actual exchange rate, 516.46, suggests the Costa Rican colón is 0.39% overvalued”.
Out of the more than 50 currencies included in the index, only eight are deemed to be overvalued in relation to the U.S. dollar:
- Swiss franc (43.5%).
- Norwegian crown (25.5%)
- Uruguayan peso (23.7%)
- Euro (3.1%)
- Swedish krona (3.1%)
- Costa Rican colón (0.39%)
- Britains Pound sterling (0.36%)
- Danish krone (0.03%)
What is interesting about this list is that the majority of these currencies are usually considered to be worth more in the index, except for the colón, which has not been in this position for over a decade.
In 2023, the dollar exchange rate experienced the largest decline since the implementation of the Foreign Currency Market (Monex, 2016) to determine currency value, when the colon appreciated by 12.2% during that year, surpassing the 9.2% increase seen in 2010.
So far this year, the downward trajectory of the dollar persists, with a reduction of approximately ¢8 this first month.
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The appreciation of the colon is being attributed to an increased availability of dollars in the foreign exchange market, primarily caused by greater foreign investment, growth in exports, and a boost in tourism.
Additionally, the high premium for investing in colones for a significant portion of the year may have also contributed to a reduced demand for dollars from savers and large investors.
Back to the Big Mac, The Economist says that “burgernomics” was never intended as a precise gauge of currency misalignment, merely a tool to make exchange-rate theory more digestible.
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Yet the Big Mac index has become a global standard, included in several economic textbooks and the subject of dozens of academic studies.
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