Purchasing Power Parity Theory and Applications for Solomon Islands

Abstract

We have tested the purchase power parity hypothesis using the consumer price index of USA and UK against Solomon Islands for the sample monthly period from January 1993 to December 2013. This paper uses cointegration and the error correction as methodologies as the data are found to be non-stationary. The result shows that the changes in Solomon Dollars (SBD) per USD are influenced by the long term trends in the price differential of Solomon Islands and the USA. We further investigate the changes in the price differential between Solomon Islands and the UK and establish that they both have a similar trend. The paper asserts that the inflation differential is in the direction of the appreciation of the SBD/USD and SBD/UK pound which supports the PPP theory in the long run. The symmetry and proportionality of the strong version of PPP were found to be very significant for Solomon Islands against UK pound sterling only and not against USA Dollars.