Understanding Fed Talk, A Guide to Commonly Used Federal Open
Market Committee Terms
The Fed Reserve (actually the Open Market Committee) typically convenes every six
weeks to discuss and economy and interest rates. It is not only the action (whether
rates are raised, lowered, or held constant), but also the accompanying committee
“statement” which is of interest to financial markets. In its statement, the Fed may signal
both its motivation for the current policy decision as well as offering clues towards the
future direction of rates. Unfortunately, the Fed often couches its commentary in vague
language and specialized terminology, which may be difficult for the uninformed to
understand. The following is designed as a handy translation guide for people who wish
to read and understand the Fed Statement. It discusses six commonly used terms in a
Fed statement, gives an example of its use, and then an explanation of the term itself.
1, Federal Funds Rate Target
“The Federal Open Market Committee decided today to keep its target for the federal
funds rate at 5-1/4 percent.”
The federal funds rate is the overnight interest rate at which banks extend overnight
loans to other banks in order to meet the required reserve ratio. This is the most
watched tool in the Fed’s arsenal, and most US short-term interest rates are directly
derived from this rate.
2. Measured Pace
“With underlying inflation still expected to be relatively low, the Committee believes that
policy accommodation can be removed at a pace that is likely to be measured.”
This term is probably the most misunderstood Fed term. At first glance, the term
“measured pace” seems to suggest that the Fed will base its monetary policy on some
kind of measurement of the economy, perhaps by observing certain economic
indicators. Actually, measured simply means gradual, or restrained. When the Fed
announces that it will raise or lower rates at a measure pace, it is relatively comfortable
with current rates, and investors should expect rates to change infrequently, perhaps
once every few months.
3. Tight Credit Conditions
“Financial markets have been volatile in recent weeks, credit conditions have become
tighter for some households and businesses, and the housing correction is ongoing.”
Now, what are credit conditions and why is the Fed always referencing them? “Credit
conditions” is a general term which refers to the cost of borrowing money, represented
by relative interest rates. In this particular instance, the Fed was evidently concerned
both about the cost of funds for businesses as well as the interest rates being paid by
households. Both rates typically trade at a spread to US government bonds, which are
considered to be the least risky investment in the world. When credit conditions tighten,
it means investors are demanding that borrowers pay higher interest rates in order to
compensate investors for what they perceive to be a higher risk of default. Thus, it is not
the tighter credit conditions (i.e. higher market interest rates) which are of prime concern
to the Fed, but rather the market perception that borrowers will have more difficulty in
making good on their loans. In a way, this signals declining investor confidence in the
economy.
4. Firming/tightening
“The Committee judges that some inflation risks remain. The extent and timing of any
additional firming that may be needed to address these risks will depend on the
evolution of the outlook for both inflation and economic growth.”
Firming/tightening is another pretentious phrase, used to indicate a hike, or rise, in
interest rates. “Tight” monetary policy is synonymous with high interest rates, and
“loose” monetary policy refers to low interest rates. The reasoning is that when rates are
high, businesses and consumers are less willing to borrow, which slows the expansion
of the money supply. Here, the Fed has issued a direct warning that it may have to raise
interest rates if inflation fails to stabilize.
5. Accommodative/easy Monetary Policy
“The Committee believes that, even after this action, the stance of monetary policy
remains accommodative and, coupled with robust underlying growth in productivity, is
providing ongoing support to economic activity.”
Monetary policy is accommodative when interest rates are low. The reasoning behind
this term is that low interest rates are designed to “accommodate” businesses and
consumers, by encouraging them to borrow money and stoke the economy. Thus, the
Fed noted that its accommodative stance was expected to provide support to the
economy.
6. Sustainable Growth and Price Stability
“The Committee perceives that, with appropriate monetary policy action, the upside and
downside risks to the attainment of both sustainable growth and price stability should be
kept roughly equal.”
While the definition of this phrase should be self-evident, it is worth drawing attention to,
because it represents a succinct version of the Fed’s mandate: to maintain economic
growth at reasonable levels and to minimize inflation. In short, even though the Fed
works by controlling the money supply, its goals are always economic growth and/or
price stability.