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The Role of Second Menu Costs – Two-Product Firms and the Real Effects of Nominal Shocks∗

Midrigan (2008) shows that if two-product firms have increasing returns in their re-pricing technology, then nominal shocks can have real effects – a result contradicting the findings of Golosov-Lucas (2007) in a model of single-product firms. This paper builds a standard menu cost model with two-product firms where the cost of changing the second price (the “second menu cost”) can be anything between zero (as in Midrigan) and the first menu cost (as in Golosov-Lucas), and shows that under reasonably calibrated leptokurtic shocks the real effect of nominal shocks is decreasing fast with the increasing relative size of the second menu cost. To identify the size of the second menu cost, we use the distributional characteristics (frequency, size, kurtosis) of micro-level price changes during the natural experiment provided by a series of large value-added tax increases in Hungary. We find that without further channels, the real effects of monetary policy in these models are still limited.