The U.S. economic outlook remains one of muddled optimism with the economy growing. Still, the expectations for renewed, sustainable growth should be tempered by the reality that COVID-19 has led to long-term malignancies in the U.S. and global economies. The jobs market has improved somewhat and a major government economic package is coming. Nonetheless, the flip side to the good news is a host of problems that will require adept economic management to offset possible setbacks. These include permanent job losses, potential increases in bankruptcies and financial instability, and rising inflation.

On the positive side:

• Vaccination efforts are making progress, with the process steadily less chaotic and the single-shot Johnson & Johnson vaccine possibly available in March. The seven-day averages of new infections and hospitalizations are falling and states such as New York and California are easing lockdown restrictions.
• The Institute of Supply Management's services purchasing managers' index (PMI) is at a 23-month high as of early February with increased expectations of job creation after being negative in December 2020. Sentiment is boosted by pent-up demand for leisure, travel and entertainment with many households that weathered the unemployment crisis sitting on piles of cash given the personal savings rate skyrocketed the past 11 months.
• New jobless claims are edging down to just under 800,000 in the most recent report, but seem stuck at about that level and are still greater than the pre-pandemic high of nearly 700,000 in October 1982.
• Additional government spending is coming, although the size and composition are still under debate, with U.S. President Joe Biden's $1.9 trillion proposal representing its ceiling. A budget reconciliation process will avoid a Senate filibuster and the need for bipartisan compromise.

The main pressure points on the economy include:

• The job market remains depressed with nearly 10 million fewer jobs than just a year ago, and many job losses may be permanent.
• Households are behind in debt payments and rent by $200 billion, and despite short-term aid will need years to dig out of financial holes. Personal bankruptcies were down by 35% in 2020, but only because of government income-support programs.
• Consumer sentiment remains depressed with consumption shifting from services to goods purchases as infection fears prolong social distancing and more contagious viral variants spread.
• Inflation will move higher. Agricultural, industrial commodity and energy prices are rising as a result of strong demand from China, goods production increasing, and supply-side disruptions such as memory chip shortages affecting the automobile industry.
• Interest rates will increase as massive supplies of government bonds enter the market and require higher yields even as the Fed tries to repress interest rates. It is willing to tolerate higher inflation than before, but faces a conundrum in maintaining quantitative easing while increasing the money supply.

In the most recent developments, the United States added a paltry 49,000 jobs in January with the entire increase due to public school teachers returning to work and no net improvement in other employment categories. Moreover, some sectors such as leisure and hospitality are mired in recession and others showed signs of slowing.

• Employment in the private sector rose by only 6,000 with manufacturing and construction jobs that had been increasing showing a combined decline of 13,000. 
• The leisure and hospitality industry lost an additional 27,000 jobs in January bringing the two-month cumulative decline to nearly 600,000. Of restaurant industry jobs regained in May-October, more than 10% of those are now lost again.
• Retail employment remains 400,000 below pre-pandemic levels. 
• The unemployment rate shown in the Bureau of Labor and Statistics household survey fell from 6.7% to 6.3%, but for the wrong reasons as 400,000 discouraged job seekers left the labor market and were no longer counted as jobless. 

'Permanent Scarring' Will Take Time to Overcome

U.S. gross domestic product may grow by 4 to 6% this year, reflecting a rebound from a low base and increased fiscal spending. Nonetheless, U.S. GDP growth was already sluggish pre-pandemic with average annual growth declining from 3.1% in 1980-2007 to only 1.7% in 2008-2019. GDP was down by 3.5% in flash reporting for 2020. A 34% annualized decline in Q2-2020 was followed by a 33% annualized jump in Q3, which gave way to a 6% annualized increase in Q4. A further slowdown is expected for Q1-2020. 

Longer-term, growth may be further slowed because income-support programs will eventually end, personal and business bankruptcies may increase, precautionary savings will remain elevated due to uncertainty, job losses will persist and change the structure of the labor market, and inflation will increase.

A new wave of business and personal bankruptcies is expected when government support programs that temporarily offset the brunt of the recession end and even well-capitalized companies may face liquidity crises. New trouble will emerge once income replacement measures and loan moratoria or forbearance ends. Timely and comprehensive data on bankruptcies is difficult to find, but personal bankruptcies were at a 35-year low in 2020 and overall filings under all bankruptcy code chapters were only down 34% from an average of 800,000 per year in recent years. Nevertheless, major corporate bankruptcies were at an 11-year high. While favorable borrowing conditions boosted efforts to maintain liquidity, higher debt service costs and leverage may not be sustainable in the long run after U.S. companies issued a record $9.7 trillion in new debt in 2020.

The labor market and job outlook are also affected by business solvency, and many job losses may be permanent. There is a high reliance on small- and medium-sized businesses for job creation and, as noted above, large additional numbers are expected to declare bankruptcy (which sets the stage to reorganize) or liquidate. Women and lower skilled employees are bearing a disproportionate brunt of the impact, which will worsen income inequality. 

• The number of jobs in the economy is nearly 10 million fewer than a year ago. More than 4 million people have left the labor force in that time, with the number of persons not in the labor force who currently want a job at 7.0 million or almost 2 million more than in February, according to the Bureau of Labor Statistics.
• The number of long-term unemployed (defined as those jobless for 27 weeks or more and not counted above) is 4.0 million, about unchanged in January and accounting for 39.5% of the total unemployed.
• At the same time, the labor force participation rate is down by nearly two percentage points to 61.5% and the employment-population ratio is 57.5%, a more than 40-year low, with women, particularly working-age mothers, bearing the brunt of the impact.
• The longer people remain unemployed or out of the labor force the harder it is to find jobs while skills atrophy, search times increase, and changing employer skill demands shift the composition of the workforce away from lower-skilled jobs. 
• In addition, productivity fell by 4.8% in the fourth quarter and unit labor costs increased at an annual rate of 6.8%, possibly contributing to lower growth and higher inflation.

Related to the employment and financial situation of households and businesses is that demand was supported last year only because real disposable income was up by 3.3% (year-on-year) in December as $1,200 individual stimulus checks, enhanced federal unemployment benefits, and Paycheck Protection Program loans maintained incomes while boosting others. The average hourly earnings of payroll workers was up by 5.4% from a year earlier, but only because there was a substantial loss of lower-paying jobs in consumer-facing services enterprises, such as restaurants and hospitality. Nonetheless, real personal consumption fell by more than 3.2% in 2020 as the personal savings rate — which averaged 6.1% from 2000-2019 — peaked at nearly 34% in April 2020 and remained elevated at almost 14% in December. It averaged more than 16% for the year; increased precautionary savings will continue to depress demand. While there is pent-up demand for some services, much activity that would have happened will not now, such as trips not taken. 

Finally, there is the question of inflation, which saps purchasing power and reduces real wealth. It has been low for some time, but recent financial market developments indicate expectations of an increase, particularly as the supply of government bonds in developed economies increases, especially with more U.S. spending. 

• Quantitative easing has provided abundant amounts of liquidity, yet the supply of U.S. broad money (M2) rose by 25% in 2020, according to the Fed, and is quadruple the increase in nominal GDP expected, which will further pressure the price level.
• If the Fed maintains or increases asset purchases, especially if it wants to control bond yields, M2 will rise further and asset prices for equity and real estate will rise further, possibly causing financial instability similar to what preceded the 2007-2008 recession.
• In contrast, if the Fed reduced quantitative easing it would immediately increase the cost of credit and reduce its availability as happened in previous episodes, including the 2013 "taper tantrum" when just the hint of the Fed cutting monetary accommodation sent markets into a frenzy.
• The Fed is willing to tolerate inflation greater than 2% for a time to offset years of below-target inflation, which stood at 1.4% in 2020. The U.S. Congressional Budget Office, however, projects a positive output gap for the next five years even without additional new stimulus. This means the economy will be operating above capacity and inflation will rise.
• In addition, industrial commodity prices are climbing with actual and anticipated firming of global industrial activity and supply shortages also possibly emerging, with a shortage of memory chips affecting the production of automobiles and other dependent industries. 
• U.S. Treasury Secretary Janet Yellen acknowledges the risk of rising inflation. But she argues that the Fed has the tools to deal with inflation, and that it is imperative to err on the side of doing too much rather than too little.