Purchasing Power Parity of Papua New Guinea: evidence from the floating exchange rate regime

Abstract

This study examines the validity of the Purchasing Power Parity (PPP) hypothesis to a developing country such as Papua New Guinea during the floating exchange rate regime. The empirical analysis was performed using recently developed Ng-Perron (2001) unit root tests which are more powerful than widely-used Dickey-Fuller-type unit roots. Ng-Perron test results indicate that the four real exchange rates (Australian dollar, Japanese yen, UK pound and US dollar) are non-stationary. Further, a comparison of exchange rates that should prevail under the PPP with actual exchange rates provides evidence that the kina was undervalued during the sample period. These results are inconsistent with the PPP and have implications for policy makers and participants of the foreign exchange market of Papua New Guinea.

Notes

¹See, Taylor (2003) and Taylor and Taylor (2004) for excellent surveys on previous studies on Purchasing Power Parity.

²Taylor (1988) pioneered the use of unit tests in testing for Purchasing Power Parity.