Purchasing power parity of Papua New Guinea: A cointegration analysis

The paper attempts to examine the validity of the Purchasing Power Parity (PPP) hypothesis for Papua New Guinea (PNG) during the floating exchange rate regime. Exchange rates for the Australian dollar, Japanese yen, the UK pound and the US dollar in terms of kina are used in the empirical analysis. Two models restricted and unrestricted are used to investigate the validity of the PPP hypothesis. For the restricted model, Johansen cointegration test finds that there are long run relationships between the kina exchange rates for the Australian dollar, Japanese yen and the US dollar and the ratio of PNG price level to price levels of Australia, Japan and the US. The results for the unrestricted model indicate long run relationships between the kina exchange rates for all the four currencies and price level of PNG and those of the four countries. These results are consistent with the PPP hypothesis. However, results for any of the currencies do not support the symmetry and proportionality conditions implied by the PPP hypothesis.