Definitions of Basic Economic and Fed-related Terms

Definition of Basic Economic and Fed-related Terms

Asset: Something of value which one owns.  Can be a physical asset, such as land, buildings or equipment, or a financial asset such as stocks or bonds.

Board of Governors: Chief governing body of the Federal Reserve system, consisting of a chairman and six governors who are nominated by the President and confirmed by the U.S. Senate.  The governors' terms run for 14 years while the chairman is appointed at four-year intervals.  Each governor is supposed to represent a different section of the country. In addition to formulating monetary policy, the Board of Governors oversees the Fed's regulatory operations as well as the payments system through which cash, checks and other forms of money are exchanged.

Bond: A financial asset that is marketable and bears a fixed rate of interest, which the issuer of the bond commits to pay to the bond's owner. Corporations and governments borrow funds from investors by issuing bonds and using the proceeds for various purposes, from buying new equipment to paving roads.

Broker: Someone who brings buyers and sellers together, or who acts as an agent of a buyer or seller in a purchase or sale transaction. In the case of transactions involving stocks or bonds, would often be called a "stockbroker."

Central Bank: Public institution responsible for controlling a country's money and banking system.  In the U.S., the Federal Reserve system is our central bank.

CD: Certificate of deposit. A certificate issued by a bank in connection with a deposit of money in that bank, which constitutes a promise to repay that money, with specified interest, at a specified date. CDs are negotiable, and there is an active market for them.

Class A, B, and C Directors: A nine-person board of directors oversees each of the 12 Reserve Banks.  The board includes three banking industry representatives and six members of the general public chosen "with due consideration to the interests... of labor and consumers" as well as agriculture, commerce, industry and services. The three banking industry representatives (so-called "Class A" directors) and three of the six public representatives (Class B directors) are elected by member banks in the district. The three remaining public directors (Class C representatives) are named by the Fed's Board of Governors.  Directors serve three year terms. The chairman of each board is selected from the ranks of Class C directors.

Commercial Bank: Bank which accepts deposits from the public and lends money to businesses and consumers. Their business lending is usually for working capital purposes--to finance payrolls, purchase of supplies, etc.--rather than to finance fixed investment or corporate restructuring, which are the functions of "investment banks."

Community Reinvestment Act (CRA): 1977 federal law which requires banks to make loans in communities in which they are located and from which they receive deposits.

CPI: Consumer Price Index, an index of prices of items which make up the market basket of goods and services that consumers typically buy.  The percentage change in this index from one time period to another is a measure of inflation (if the index has increased) or deflation (if it has decreased)--also known as the change in the "cost of living."

Credit: Access to loans, usually short-term, either from a bank or other financial institution, or from a retailer, wholesaler or supplier, usually to cover the cost of goods or services purchased.

Creditors: Lenders; those who are owed money or supply credit.

Debt: an obligation to repay borrowed money, or to pay for goods or services acquired on credit. Interest is payable on most forms of debt, and repayment dates or schedules are usually specified. Often debt certificates are marketable, in the form of "bonds."

Debt-to-Income Ratio: This is the amount of debt owed by an individual, household or nation, divided by its income. It is one rough measure of the "burden" of their debt--a high ratio represents a heavy burden, while a low ratio represents a light burden.

Debt Service: The amount of interest due on a debt in order to regularly pay off or "service" that debt.

Debtors: Borrowers; those who borrow money.

Defined Benefit Pension: This is a federally insured pension which provides a guaranteed monthly pension benefit amount.

Deflned Contribution Pension: A pension plan in which the worker's benefit fluctuates depending on the investment performance of funds contributed to the plan. Defined Contribution pension plans are not insured by the federal government.

Deflation: A general decline in the level of prices.

Discount Rate: the interest rate which the Federal Reserve system charges member banks when they borrow directly from the Fed.  The Fed's Board of Governors sets the discount rate, in consultation with the boards of its 12 regional banks.  Changes in the discount rate are one of the tools available to the central bank for carrying out monetary policy.

Disposable Income: The amount of income people have left over after paying their taxes.

Dividends:  Payment by a corporation to its shareholders, either in cash, or in the form of additional shares of the corporation's stock.  Usually, these payments are made out of the corporation's profits.

Dow Jones Industrial Average: An average of stock prices that serves as a barometer of the market as a whole.  This average, calculated daily, is based on 30 industrial stocks.

Easy Money: Low interest rates and easy availability of credit, resulting from the Federal Reserve's monetary policy decisions.

Economic Growth: The rate of increase in "real," i.e., inflation-adjusted, national income or national product between one time period and another.  If all resources in the economy (labor, capital and land) are fully employed, the economy can grow no faster than the growth in these resources, as augmented by productivity gains.  If, on the other hand, resources are not fully employed (for example, because workers are unemployed), there is no constraint on the economy's growth rate until full employment has been achieved.

Employment Act of 1946: This landmark law requires the federal government to do everything in its power to create and maintain employment opportunities, sustained economic growth and stable purchasing power. It also created the President's Council of Economic Advisors, and the Joint Economic Committee of Congress.

Federal Funds Rate: The interest rate banks charge one another for overnight loans to meet their reserve requirements. It is a benchmark for all short-term interest rates. This is the interest rate that the FOMC targets, and manipulates, through its open market operations, in order to speed up or slow down the economy. When banks have to pay a higher rate to borrow in the federal funds market, they raise rates on loans to their customers, to defray the cost increase.

Federal Reserve: America's central bank, a government agency that controls the amount of money in our economy. The Fed also regulates the cost of borrowing money, and oversees the banking industry.  Conducting these activities makes the Fed one of the most powerful influences over our pocketbooks.

Federal Reserve Act: In 1913, Congress passed the Federal Reserve Act, the legislation that created the Federal Reserve System. Its architects hoped that by stabilizing the country's monetary system the Fed would help end the extreme boom-bust cycles and the periodic financial panics that pounded the U.S. economy during the decades following the Civil War.

Federal Open Market Committee (FOMC): The key monetary policymaking body within the central bank. The FOMC meets eight times a year to map out the Fed's sale and purchase of government securities in the "open market."

401(k): A type of defined contribution pension plan which derives its name from the section of the tax code that allows companies and their employees to get tax write-offs for the contributions they make to such plans, and which allows the funds invested in such plans to accumulate taxfree. There has been a tremendous increase in size and coverage of 401(k) plans in recent years.

GDP: Gross Domestic Product. This is the value of all goods and services produced by labor and property located in the U.S. during a year.

Household Debt: Credit card debt, car loans, personal loans and home mortgages.

Humphrey-Hawkins Act: Also known as the Full Employment and Balanced Growth Act of 1978, it requires the Fed to pursue policies that promote full employment (defined as a maximum of 4% total unemployment, and 3% adult unemployment), as well as stable prices.

Income: Money received during a period of time from wages and salaries--or, if you have
wealth--from dividends, interest or rents.

Inflation: The percentage increase in cost over a period of time--usually a year-- of the items
people typically buy on a regular basis, such as food, clothes, and groceries.

Interest Rate: The price of money--what you have to pay lenders for advancing you credit.

Inflation-Indexed Bonds: Bonds whose principal and interest payments are adjusted to offset the effects of inflation.  For example, if the principal of a bond was $10,000 initially and the inflation rate is 2.5%, at the end of one year the principal would be adjusted to $10,250. The federal government recently started issuing such bonds, which are intended to protect savers against the impact of inflation.

Investment Bank: A financial firm that underwrites, or arranges the sale, of stock and bonds for companies.  Investment banks also implement a variety of corporate restructuring activities such as mergers and acquisitions.  Investment banks do not accept deposits from the general public; traditionally, they have not made the same kind of loans that commercial banks do.

Liabilities: Debt obligations owed by an individual, household, business or government.

Long-Term Interest Rates: Interest rates on long-term loans or long-term bonds, i.e., loans
with a repayment date or bonds with a maturity date of more than one year.

Mack Bill: Proposed legislation introduced by Sen. Connie Mack (R-FL), which would abolish
the legal requirement that the Fed pursue full-employment.

Member Bank: Commercial banks that belong to the Federal Reserve System. All federally chartered banks (those with the word "National" in their name) must be member institutions, and many state-chartered banks choose to be.

Monetary Policy: Policies carried out by the central bank to manipulate interest rates and credit conditions, in order to influence the general level of economic activity. Monetary policy is a powerful tool for influencing the level of employment, economic growth and the rate of inflation.

Money Supply: The amount of money in the economy. There are various definitions of "money" for this purpose, but a common one is the sum of currency in circulation plus bank deposits.  The central bank is responsible for monitoring the money supply, and can influence its size by using the tools of monetary policy.

Mortgage-Backed Security: A financial instrument created by bundling together separate mortgages written by banks and other lenders. The security that pools together the mortgages are sold (and usually re-sold) to large investors.

Mutual Fund: A financial corporation which sells shares to investors, and pools the proceeds to buy financial assets such as stocks or bonds.

NAIRU: A theory that there is a minimum level of unemployment below which wage increases and therefore inflation must inevitably accelerate.  NAIRU stands for the (N)on-(A)ccelerating (I)nflation (R)ate of (U)nemployment.  According to this theory, if unemployment drops below the NAIRU, workers simply get too powerful and bid up wages beyond the ability of employers to pay. Employers respond by raising prices, and inflation is off to the races.

Open Market Operations: The Fed's main tool for influencing interest rates is known as "open market operations"--the buying and selling of already-issued U.S. government bonds.  When the Fed sells bonds from its inventory, it takes money out of circulation.  Less money in circulation means less money is available for banks to lend-which drives up interest rates.  When the Fed buys bonds, the process works in reverse.  This puts more money into circulation; more money in circulation means more money is available for banks to lend-which pushes interest rates down.

Per Capita: This means per person.  For example, per capita household debt tells how much debt each person would owe if the total of all household debt were divided equally among everyone.

Real Interest Rates: Interest rates adjusted to take out the effect of inflation.  For example, if the nominal interest rate is 6% and inflation is 2.5%, then the "real" interest rate is 3.5% (6% minus 2.5% equals 3.5%).

Real wages: wages adjusted to take out the effect of inflation.

Recession: A period when business production, employment and earnings fall below levels which the economy is capable of achieving.  A period when national income declines for two or more consecutive 3-month periods.

Reserve Requirement: The percentage of its deposits which a bank is required to keep in the form of cash on hand, or on deposit with the Federal Reserve.  For example, if a bank takes in $1 million in deposits and the reserve requirement is 12.5%, the bank must keep "reserves" (the sum of cash on hand, plus deposits by the bank with the Federal Reserve) of at least $125,000.  Reserve requirements are set by the Board of Governors, and are one of the tools available to the Federal Reserve for carrying out monetary policy.

Securities: A term for financial assets such as stocks and bonds.

Short-Term Interest Rates: Interest rates on short-term loans or short-term bonds, i.e., loans
with a repayment date or bonds with a maturity date of one year or less.

Stock: Financial assets which represent shares of ownership in a company.

Tight Money: High interest rates and lack of availability of credit, resulting from the Federal
Reserve's monetary policy decisions.

Unemployment Rate: This is the number of people out of every 100 people who are actively
looking for work, and who don't have a job.

Wall Street: Famous street in Manhattan's financial district where the New York Stock
Exchange is located.  More generally, the term.for high finance--big banks, brokerages, insurance companies and others--and those whose economic interests are identified with high finance.

Wealth: This consists of physical goods, such as real estate, jewelry, autos and so forth, which
can be exchanged for money; it also includes financial assets such as stocks and bonds.