Thursday, January 24, 2013

Can IKEA replace the BigMac or the Ipod?

When a good is exported and exchange rates fluctuate, how much of the exchange rate change is reflected in local pricing? Establishing the extend of this pass-through has been the subject of an extensive literature over the past years as international price datasets have been made available. A major difficulty is with the coding of the goods, and one is not always sure that goods in different countries are comparable.

Anthony Landry and Marianne Baxter fix this issue by looking at the IKEA catalog in six countries over seven years. Part of the IKEA catalog is marketed in several countries, and these goods are identical and produced in the same country. The prices are valid for a full year, though, so the prices also reflect how the company thinks the exchange rates will move over the next year (How does IKEA do in high inflation countries?). Pass-through is estimated to be about 14-30%, which is low but may reflect the fact that the forecasts made by IKEA end up being smoother than actual exchange rate movements.

There is one aspect that I find very exciting in this data. Could the IKEA be a replacement for the Big Mac index that the Economist has popularized? The latter measured whether currencies are over- or under-valued by looking at exchange rates and local prices of a supposedly uniform good. As I argued before (I, II), the Big Mac is, however, not uniform, and meat or other components are sometimes local and of different quality, especially because there may be some local regulations for food products. In addition, a Big Mac contains a service component that is priced in as well, and MacDonald restaurants are definitively not comparable across countries. I better indicator was the iPod index, as this is a uniform good across all countries, unfortunately it looks like the iPod is going to go the way of the dodo within a few years. Could the IKEA catalog be the a good candidate? I think so, as it contains many goods that are available in several countries, and thus we have ways to take into account when a good is dropped from distribution. The drawbacks are the limited number of countries (IKEA is present in 40) and the annual frequency. And the fact that IKEA is making bets over future exchange rates with its pricing.

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