The Fed categorizes money based on its liquidity. It is divided into three categories:
- M1 - The actual cash money supply, spending money, checking accounts and currency
- M2 - A larger category that includes M1, small savings accounts and time deposits at banks, and money market mutual funds
- M3 - Larger and less liquid, including corporate CDs, etc.
In order to develop the nation's monetary policy, the FOMC looks at many economic indicators. This gives the FOMC a feel for what the economy is doing and what direction it may be taking. It also looks to the The Beige Book, which is a report that summarizes comments received from businesses and other contacts outside of the Federal Reserve. This, in addition to economic indicators, forms the basis for the FOMC's monetary policy.
The Federal Reserve chairman accesses data about the economy every half hour or so when things in the economy are calm, and every 15 minutes when things aren't. This is simply to make sure nothing is happening in the economy that the chairman doesn't know about. The chairman can also tap into a network of business contacts that provide insight into a wide range of businesses, revealing who is buying what and in what amounts. By staying on top of where the economy is right now and where it is going, the Fed can project future changes and act accordingly.
Here are the economic indicators examined by the Fed:
- Consumer Price Index (CPI) - This indicates the change in price for a fixed set of merchandise and services intended to represent what a typical consumer might purchase over a given period. It is compiled monthly by the U.S. Department of Labor's Bureau of Labor Statistics. By keeping track of the rate of change in the CPI, the Fed can get an accurate measure of inflation.
- Real Gross Domestic Product (GDP) - The GDP is the total of all of the goods produced in the United States, regardless of who owns them or the nationality of the producers. The measurement is produced quarterly and accurately represents national output, meaning it uses real terms so inflation doesn't distort the numbers. It is used as an indicator of the performance and growth of the economy.
- Housing Starts - Because housing is very sensitive to interest rates, this indicator is tells the FOMC how financial changes are affecting consumers. Housing starts are an estimate of the number of housing units that started construction in a given period. The report is produced monthly.
- Nonfarm Payroll Employment - This measurement includes the total number of payroll jobs that are not in the farming business. It is produced each month by the U.S. Department of Labor's Bureau of Labor Statistics and also includes information about the total number of hours worked and hourly wages earned by workers. It is helpful to the FOMC as an economic indicator because it indicates the pace (or changes in the pace) of economic growth. The average hourly earnings number also shows trends in supply and demand.
- S&P Stock Index - The Standard & Poor Index shows the FOMC the changes in price in a very wide variety of stock. S&P compiles the index daily. The value of watching this index as an indicator of the economy is that it often indicates the confidence consumers and businesses have in the economy. If the market is rising, then investments and spending will rise; if the market is low or falling, then investments and spending will also slow down.
- Industrial Production/Capacity Utilization - This measures industrial output both by product and by industry. It is compiled by the Board of Governors each month and is useful because it tells the FOMC about the current growth of the Gross Domestic Product. By understanding the level of capacity utilization, the FOMC can understand how well resources are being utilized. All of this can indicate future changes in the rate of inflation.
- Retail Sales - This is a total of all merchandise sold by retail merchants in the United States. The numbers are presented in dollar amounts, and are adjusted for seasonality but not for inflation. The U.S Department of Commerce produces this report each month. This measurement tells the FOMC how much consumers are buying. This is called the personal consumption expenditure and indicates future growth or lags in the economy.
- Business Sales and Inventories - This is a measurement of the total sales and inventories for the manufacturing, wholesale, and retail sectors. This report is compiled monthly by the U.S. Department of Commerce and can be a good indicator of growth or slow downs in the economy because it shows the level of inventory and whether it is moving or not. Inventory that isn't moving indicates a future slow down; inventory that is moving may indicate an increase in future production.
- Light-Weight Vehicle Sales - Because changes in car sales can account for a large portion of the change in the GDP from quarter to quarter, this measurement has to be taken into account. The report is compiled by Ward's Automotive Reports and the American Automobile Manufacturer's Association, and seasonally adjusted numbers are generated by the U.S. Department of Commerce and the Bureau of Economic Affairs.
- Yield on 10-year Treasury Bond - This is simply the current market rate for U.S. Treasury bonds that will be maturing in 10 years. This is good as an indicator because mortgage rates tend to follow it. Changes in mortgage rates, in turn, indicate future changes in the housing industry.
- M2 - Because there is often a link between the supply of money and the growth of the GDP, this measurement is yet another indicator that the FOMC looks to when making decisions about monetary policy. The report is produced by the Board of Governors weekly and monthly.