A comparison of menu costs in open and closed economies with a mixed industrial structure

In this paper we develop Dixon and Hansen (1997) to allow for two-sector sm all open economy in which the non-traded sector is monopolistic. The closed economy version of the model generalises Dixon/Hansen to allow for diminis hing returns on the traded sector. We compare the short-run impact of menu costs on the economy and also the size of menu costs needed to sustain nomi nal rigidity in both the open and closed economies. We find that whilst the welfare gains from monetary expansion are of a similar magnitude, nominal rigidity can occur for much smaller menu costs than in the closed economy c ase. Hence we argue that menu costs and the resultant nominal rigidities ar e more likely to be important in an open economy.