| Sumario: | The welfare of an open economy heavily reliant on foreign trade can be significantly affected by foreign price instability. An investigation considered whether a domestic price stabilization policy can improve such an economy's welfare under unstable foreign price conditions. The condition for benefits from passive foreign price stabilization was delineated in terms of the observable characteristics of the import demand function and risk attitude. A feasibility condition was then incorporated to investigate the optimality of domestic price stabilization. A small nation can benefit from active domestic price stabilization if the condition for benefits from passive price stabilization is met. When international commodity agreements are hard to achieve, a small nation can mitigate external shocks by independently pursuing domestic price stabilization. Complete stabilization of the domestic price of imports is never optimal, however, regardless of risk aversion.
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