Dual Labour Markets and Menu Costs: Explaining the Cyclicality of Productivity and Wage Differentials

Huw Dixon, Claus Thustrup Hansen and Henrik J. Kleven
Authors registered in the RePEc Author Service: Claus Thustrup Kreiner

No 99-13, EPRU Working Paper Series from Economic Policy Research Unit (EPRU), University of Copenhagen. Department of Economics

Abstract: The conventional menu cost framework performs poorly with realistic labour supply elasticities; the menu costs required for price rigidity are very high and the welfare consequences of monetary disturbances are negligible. We show that the presence of dual labour markets greatly improves the performance of the framework both by reducing menu cost requirements and by boosting the welfare consequences. In addition, the introduction of dual labour markets provides an explanation of procyclical productivity and the shrinking of wage differentials during booms, in line with stylized facts on business cycles.

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