I believe that it's meant to encompass music that is closely aligned to, or actually is, traditional music in the sense of: music that's been handed down over generations, is connected with a particular culture, etc. Not singer-songwriters, unless they are closely aligned with some sort of culturally specific group. It's meant to make space for traditional music that doesn't fit into the other categories, like Irish reels, old-time ballad singing, etc. There was a lot of discussion amongst the folks who organize the Grammies about this over the past few years, largely because of the lobbyists for Americana. What has happened now is that there are 2 "Folk" categories, one for Americana/singer-songwriters/contemporary folk, and the other for "traditional" folk.

All you Mudcatters who play traditional music and put out a CD, please consider joining NARAS and submitting your CD for a Grammy! If they don't get more submissions in the traditional folk field, NARAS (the Grammy organization) will simply discontinue that field. Remember, even if you don't stand a chance of winning, submitting will mean that your CD will get noticed by the experts in the field who sit on the sorting and nominating committees, and those experts do include record company executives, radio folks, and other movers and shakers in the folk music world. You can find more info at the NARAS website: http://www2.grammy.com/Recording_Academy/Member_Services/FAQs/
Best,
Suzy