I have not experienced this with my own children, but do know another child (not PG) who did this at about a year or two older in age. This child could stay in role for days, insisting with a totally serious expression that some patent untruth was so, including copious detail, even when logical inconsistencies were found, or a reliable reporter had contradicted them, coming up with ever more outlandish explanations for the inconsistencies. This went on for several years, actually, from about age 7 to around age 10, when the behavior faded on its own. The child is still a highly creative person. What I ended up doing in my interactions with this child was entering into the spirit of the story for a few minutes, and then ending with comments like, "You are a marvelous story-teller," accompanied by a warm smile and a twinkle. I won't claim that this would be the way to handle every child with this behavior, but in this case, it seemed to work as both an acknowledgement of the untruth of the statements, and an appreciation for the creativity involved.
I would throw a couple of thoughts out there: your child is around the age when, developmentally, children are exploring the boundary between reality and fantasy. It is not uncommon for kindergartners to invent elaborate imaginative explanations for observed phenomena. I seem to remember a book in grad school that was all about the extended fantasies created by a group of kindergartners in a uni lab school, mostly led by one boy. The title and author escape me, at the moment.
Secondly, even confabulations communicate something real about thoughts, feelings, and perceptions, if sometimes a bit dressed up. Is there any theme to the stories--an emotional thread, persistent reference to certain types of ideas, tasks, or relationships?
Thirdly, do you have any other reason to suspect poor reality testing, other than the story-telling? If not, I would not be nearly as concerned about distinguishing reality/fantasy.