Hanging on every word.

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5 Questions for Janet Yellen

Mohamed A. El-Erian is a Bloomberg View columnist. He is the chief economic adviser at Allianz SE and chairman of the President’s Global Development Council, and he was chief executive and co-chief investment officer of Pimco. His books include “The Only Game in Town: Central Banks, Instability and Avoiding the Next Collapse.”
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Federal Reserve Chair Janet Yellen will deliver her semi-annual testimony to House and Senate committees this week. Her remarks will be closely monitored, especially in light of the recent increase in global economic insecurity -- which has intensified talk of a recession threat -- and global financial volatility.

QuickTake The Fed Lifts Off

Here are five questions that she should be asked as part of her broader evaluation of economic developments, the outlook and prospects for Fed policy.

  1. How is international weakness influencing U.S. economic prospects? The jobs report for January released on Friday suggested that the economy is in relatively good (though not great) shape, despite mounting worries about the global outlook. There will be lots of interest in Yellen’s forward-looking assessment of U.S. economic resilience, particularly given the recent sharp fall in Treasury yields, which is viewed by many as a signal of future weakness. 
  1. Is the recent acceleration in wage growth sustainable? Although the U.S. has been one of the world's most powerful engines of job creation in recent years, the recovery of the labor market has not yet been accompanied by solid increases in wages. Data in the January employment report -- particularly the increase in both hourly earnings and hours worked -- have led to predictions of more robust wage growth ahead. Employees and investors will be eager for Yellen’s assessment of how this is likely to play out.
  1. Is inflation or deflation the main risk to the U.S. economy? The possibility of higher wage growth suggests an upward trend for inflation. But there also are forces pushing in the other direction, including the further fall in oil prices over the last few months, which has added to the deflationary trends in Europe in particular. Several countries continue to be inclined to rely on policies that export deflation, such as currency devaluations, as they struggle to maintain domestic growth. And companies remain quite risk averse, and are hesitant to deploy their considerable cash holdings for expansionary spending on new plants and equipment. Yellen could provide guidance on how the balance of these forces evolves.
  1. Does the sharp decline in banking-sector stocks indicate a new problem? Stock markets have repriced the valuation of banks sharply lower, largely because of concerns about loan exposure to the energy sector and the relentless compression of net interest margins. Investors will be looking for Yellen to indicate whether this suggests systemic problems or reflects a new and eventually stable valuation paradigm.
  1. Will financial market volatility contaminate the economy? The recent behavior of markets has raised questions about the effectiveness of continued unconventional policies by central banks as a means to boost economy activity. The growing recognition that these institutions are less able (in the case of the euro zone, China and Japan) and less willing (the Fed) to consistently repress financial volatility raises questions about the possibility of adverse spillovers into the broader economy. Yellen could provide an assessment of the risk.

Yellen’s remarks will influence the markets' outlook for the U.S. economy and the prospects for Fed policy, including the potential frequency and timing of future interest rate actions.

Unfortunately, her comments are unlikely to serve -- for the moment, at least -- as the catalyst for the most urgently required action to ensure sustainable economic prosperity and genuine financial stability: A decision by lawmakers on Capitol Hill to shift U.S. macroeconomic policy away from excessive reliance on the Fed and toward a more comprehensive approach that removes structural impediments to growth, including outdated infrastructure, tax distortions and inadequate investments in human capital. This change also would need to deal with aggregate demand deficiencies, eliminate crushing pockets of over-indebtedness, and help restore U.S. leadership thanks to more effective global policy coordination.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Mohamed A. El-Erian at melerian@bloomberg.net

To contact the editor responsible for this story:
Max Berley at mberley@bloomberg.net