Beginner's Glossary of Economic Terms
Sharon with Jean Claude Trichet
Reading through our website and press releases, you may from time to time come across a word or acronym you do not understand.
We have tried here to provide a very simple glossary to some of the most frequent terms you will see discussed on our site.
We would like to stress that these definitions are summing up legislation or concepts that are sometimes exceedingly complex. To give an accurate definition would take many more paragraphs!
This glossary just gives a very basic, entry-level explanation of what that term refers to. We have provided links to other websites if you are interested in more precise and expanded definitions.
We hope this glossary is helpful. If there are any terms that you feel we should include here, please do let us know
This page is still under construction. Apologies if the term you wanted to know more about is not yet featured!
A
Aggregate Demand
The total demand for goods and services in an economy.
Aggregate Supply
The total supply of goods and services in an economy.
Alternative Investment Fund Managers Directive (AIFM)
Simple answer: AIFM is the name for a piece of controversial European Legislation that was passed in 2010. AIFM stands for Alternative Investment Fund Managers. The aim of this legislation is to make investments more transparent and less risky in Europe.
Arbitrage
Arbitrage is where a trader buys a financial product on one market and sells it on another market for a profit (i.e. someone buys a book from Waterstones for £5 and sells it on Amazon for £6, making a profit of £1).
B
Basel Committee
The Basel Committee is a group of top bankers which meets four times a year to discuss banking and supervision.
BIS
The Department for Business, Innovation and Skills - a UK government department responsible for a diverse range of policy areas, including higher education, science, research, and trade.
Book Entry Securities
Securities that are recorded in electronic records called book entries, rather than as paper certificates.
C
Capital
Wealth in the form of money or property.
Or
Material wealth used to produce more wealth.
Or
Machines, factories, and infrastructure used to produce output.
Capital Requirements Directive (CRD I, II, III and IV)
The Capital Requirements Directive (CRD) is an EU law which requires banks to have enough capital to stay afloat if they should run into difficulties. CRD 3 (the third version of the law passed in 2010) introduced rules on 'contingent capital' whereby a proportion of profit used to pay bonuses is set aside for a period of five years in case it is needed to combat a recession slump.
Cartel
A group of firms that acts as a single co-ordinated whole to agree prices. Some cartels also collude to restrict output and drive up prices.
Central Counterparty Clearing House (CCP)
An organisation found in many European countries, a CCP acts as an overseer between sellers and buyers of derivatives and equities ensuring that transactions are honoured on both sides. Clearing houses are often operated by major European banks.
Collateralised Debt Obligation (CDO)
Example: Investors give a CDO manager money to invest. The manager then buys slices of securities (credit card debts, student loans, etc). In this example he buys mortgages. The CDO manager then creates a capital structure resembling a pyramid of champagne glasses. Each glass represents an investor and is rated according to risk (in descending order). At the top of the pyramid is the least risky (AAA). At the end of every month the mortgages pay interest (profit). This interest flows into the pyramid of glasses with the least risky (AAA) profitiing first and then the rest. During the housing boom in the US, everyone in the pyramid got paid. However, when people started to default on their mortgages, interest dried up and consequently some of the more risky investors at the bottom of the CDO pyramid stopped getting paid.
Commodity Markets
Commodity markets are markets where raw or primary products are exchanged. These raw commodities are traded on regulated commodities exchanges in which they are bought and sold in standardised contracts.
Consumer Price Index (CPI)
National Statistics 'market basket' used to measure changes in the prices of goods and services bought by a typical household; complements and in some cases replaces the Retail Price Index (RPI).
Consumer Surplus
The benefit consumers get when they can buy something for less than the maximum amount they are willing to pay for it.
Credit Default Swap (CDS)
Example: A buyer purchases 5000 company bonds. The buyer can then purchase a Credit Default Swap (a sort of insurance contract) to cover himself if the market value of the bonds drops significantly (i.e. if the bonds default). Essentially, the buyer is swopping the risk that the bonds may default by paying an insurer a monthly premium to cover him if they do. At his end, the insurer must put up a lump sum (collateral) so that the buyer is confident the insurer has enough money to cover him if the bonds default. If the market takes a turn for the worse and the value of the bonds starts to drop, the buyer may decide to sell the bonds. In this instance the insurer would have to make up the difference (loss) in price. This could cause the insurer to be out of pocket. Also, if the credit rating of the insurance company is downgraded, the buyer can (if it is in the contract) ask for the collateral to be increased. These 'collateral calls' can drag a company down by putting pressure on its capital reserves. This is what happened to AIG during the financial crisis.
Naked Credit Default Swap (Naked CDS)
Naked Credit Default Swaps make up the bulk of the lucrative CDS market. This time the buyer of the Credit Default Swap has yet to buy the bonds he wants to insure. Having bought the Credit Default Swap, the buyer then purchases the bonds hoping they will default so that he can collect the collateral payment. The problem with Naked CDS is best summarised: 'Naked Credit Default Swaps are like buying fire insurance on your neighbour's house - you create an incentive to burn down the house.'
Credit Rating Agency (CRA)
Credit Rating Agencies are companies that rate certain types of debt and issuers of debt according to risk. AAA is the highest (i.e. least risky) rating.
D
Deflation
When the overall level of prices in the economy is falling.
Demand Curve
A line on a graph that represents how much of a good or service buyers are going to consume at various prices.
Depreciation
A reduction in the value of a product or asset over time.
E
ECOFIN
The configuration of finance ministers from the 27 Member States of the EU.
Economic and Monetary Affairs Committee (ECON)
The committee of the European Parliament that debates and amends proposed legislation pertaining to Economic and Monetary Affairs in the European Union. Often abbreviated to 'ECON', the committee's position on a piece of legislation is usually put to the Commission and Council of Ministers by the committee's Chair. The current Chair of ECON is Sharon Bowles MEP.
European Central Bank (ECB)
The ECB administers monetary policy in the Eurozone countries. The current President of the ECB is Jean-Claude Trichet.
European Economic Area
The European Economic Area was established in 1994 by the European Union to allow Iceland, Liechtenstein and Norway to participate in the EU's single market without a conventional EU membership.
Eurozone
An economic and monetary union (EMU) of 17 EU Member States that have adopted the Euro as their common currency and sole legal tender.
Ex-Ante
Describing any predicted future event. For example, an analyst may predict a company's earnings 'ex-ante' and then compare its actual earnings to gauge the accuracy of the prediction.
Ex-Post
In models where there is uncertainty that is resolved during the course of events, the ex-post values (e.g. of expected gain) are those that are calculated after the uncertainty has been resolved.
F
Financial Markets
Markets where people trade the property rights to assets (such as real estate or stocks) or where savers lend money to borrowers.
Fiscal Policy
A government's policy on taxes and spending.
FSA
Financial Services Authority - an independent body that regulates the financial services industry in the UK.
G
Gross Domestic Product (GDP)
The value of all goods and services produced in the economy in a given period of time, usually a quarter or a year.
H
Hedging
Just like the expression 'Hedging your bets', the economic term hedging means a way of offsetting the risk of an investment, i.e. betting both ways. Hedge fund managers are experts at hedging and will often make money by betting against the success of their investments.
Hedge Fund
A hedge fund is set up as a company and is made up of wealthy investors who pool their money thereby allowing a hedge fund manager to invest on a bigger scale and make bigger profits. Hedge fund investors are normally locked in for a period of time. The current 'King of Hedge Funds' is John Paulson.
Holistic
Relating to a study of the whole instead of a separation into parts.
Hyperinflation
When the inflation rate exceeds 20 or 30 per cent per month.
I
Inflation
When the overall level of prices in the economy is rising.
Inflation rate
A measure of how the overall level of prices in the economy changes over time. If the inflation rate is positive, prices are rising. If the inflation rate is negative, prices are falling.
Interest rate
The price you have to pay to borrow money, or that is given when you place money in an institution.
J
Junk Bond
A high-risk bond with a low credit rating, usually BB or lower; as a consequence, it usually has high interest rates.
K
L
Leveraging
Leveraging means borrowing money and is often described as a ratio (i.e. debt to capital). Some banks were leveraged 25 times during the financial crisis which means they had borrowed 25 times more money than they had on their books. Banks and hedge funds will often leverage in order to maximise their investment potential.
M
Macroeconomics
The study of the economy as a whole, concentrating on economy-wide factors such as interest rates, inflation, and unemployment.
Market Economy
An economy in which almost all economic activity happens in markets, with little or no interference by the government; often referred to as 'laissez-faire' ('leave alone') economic system.
Market Makers
A dealer in securities or other assets who undertakes to buy or sell at specified prices at all times.
Markets
Places where buyers and sellers come together to trade money for a good or service.
Microeconomics
The part of economics that studies individual people and individual businesses.
MiFID
The Markets in Financial Instruments Directive (MiFID) is a European Union law which provides regulation for investment services across the 30 Member States of the European Economic Area.
Monetary Policy
When a national government uses changes in the money supply to change interest rates in order to stimulate or slow down economic activity.
Monopoly
A firm with no, or virtually no, competitors in its market.
N
National Deposit Guarantee Schemes
If a bank closes down, National Deposit Guarantee Schemes exist to reimburse account holders of the bank up to a certain coverage level.
O
Oligopoly
A market with only a few firms (i.e. mobile phone companies).
P
Q
R
Recessions
A period of temporary economic decline during which trade and industrial activity are reduced, generally identified by a fall in GDP in two successive quarters.
Rumourtrage
The practice of spreading false news about a company (i.e. 'Pump and Dump' and 'Trash and Cash')
S
Securitisation
Securitisation is the practice of putting different types of debt together and selling that debt off in slices to various types of investors (i.e. CDO managers). Slices are rated according to risk.
Short Selling
Short selling is a type of investment whereby an investor rents shares from another investor (for a fixed fee and for a fixed period of time). The renter then sells the shares while the price is high and buys them back when the price is low, profitting from the difference in price. The renter then returns the shares to the original owner.
Naked Short Selling
Naked short selling is a type of investment whereby the short seller (renter) promises shares to an investor for an agreed price before he has acquired the shares. He then buys the promised shares at a lower price than that agreed and delivers them to the investor, profitting from the difference in price.
SMEs
Small and Medium Enterprises
SMPs
Small and Medium Size Practitioners
Subprime Mortgage
Subprime mortgages are a type of mortgage, pioneered in the US, given to those who would normally be denied a mortgage due to poor credit history / insufficient upfront capital. The collapse of the Subprime mortgage market in the US has been widely attributed as the catalyst for the recent financial crisis.
Subsidiarity
The principle of devolving to the lowest practical level.
Supply Curve
A line on a graph that represents how much of a good or service sellers are going to produce at various prices.
T
Treasury
A UK government department responsible for developing and executing the British government's public finance policy and economic policy. The Treasury is headed by the Chancellor of the Exchequer.
U
V
W
Write-Down
A reduction in the estimated or nominal value of an asset