Dual labour markets and nominal rigidity

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 the minimum effective menu costs 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.