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IN A RECENT ISSUE of this Journal Professors Bonomo and Schotta presented evidence on the nature of open market operations.' Bonomo and Schotta use regression analysis to determine the fraction of changes in factors affecting free reserves and total reserves which have been offset by defensive open market operations.2 However, Bonomo and Schotta misspecify the importance of the regression constant, and as a result of this misspecification, the conclusions they reach are inappropriate. The estimating procedure employed in their study makes use of the following equations (6 and 7):3 AR=al + P AR* + (o and AFR = a2 + 32 AFR* + o2 where ARweek-to-week change in total reserves, AFR = week-to-week change in free reserves, AR* week-to-week change in factors affecting total reserves other than open market operations, AFR* week-to-week change in factors affecting free reserves other than open market operations, a,, a2 estimates, allegedly, of net of other factors influencing open market opera-A A tions, i.e., dynamic objectives; and Pt,2 2 =estimates of (1 + k1) and (1 + k2). Bonomo and Schotta assume that the equation constant may be treated as representing the dynamic element in open market operations. Their results indicate that the constants, al and &2, are not significantly different from zero at the 1 per cent level;4 therefore, the conclusion to be drawn from their tests is that the System has not conducted dynamic open market operations with regard to total reserves since 1949 nor with regard to free reserves since 1945! This conclusion, that ". . . the dynamic element, . . ., is zero for all but 5 of the individual annual periods" (P. 662), results from the fact that Bonomo and Schotta have equated dynamic operations with a monotonic time trend variable-the equation constant in a first difference regression.5 There are several plausable reasons why Bonomo and Schotta's regression constants are not statistically significant. First, it may be due to the strong seasonality of the unadjusted weekly data. Secondly, it may 1.

THIS PAPER USES time series data to measure the probable magnitude of the "real balance effect" in the short-run in the United States during the post-war period. Although the "real balance" hypothesis is usually advanced as a proposition in the theory of long-run equilibrium, nevertheless many economists recommend stabilization policy which assumes the existence of a strong real balance effect in the short run.The real balance hypothesis is stated and statistically tested below in multivariate form, using quarterly series for personal saving, personal disposable income, individually-held real balances, and an interest rate measure. The evidence from this analysis is interpreted as indicating a nonexistent short-run real balance effect, while leaving in doubt the issue of a long-run real balance effect. It is suggested that policies based on a short-run version of the real balance hypothesis cannot be effective as counter-cyclical stabilization measures.In the first section, the real balance theory is briefly discussed as a background for formulation of a statistical hypothesis. In the second section recent empirical work bearing on the probable magnitude of the effect is noted and two direct tests of the theory are criticized. In the third section the results of the present tests of the statistical real balance hypothesis are presented and discussed. The implications of the study are examined in the final section.

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