How should we interpret the May jobs report? Is the coronavirus recession over already? What will the economy look like heading into the summer and beyond? And what do we need policymakers to do going forward? Michael Strain joined the Political Economy podcast last week to discuss the pandemic economy as summer arrives and restrictions lift.

Michael is the director of economic policy studies and the Arthur F. Burns Chair in Political Economy here at AEI. He is a columnist for Bloomberg Opinion, and his essays and op-eds have been published by The New York Times, The Washington Post, The Atlantic, National Review, and The Weekly Standard.

What follows is a lightly edited transcript of our conversation, including brief portions that were cut from the original podcast. You can download the episode here, and don’t forget to subscribe to my podcast on iTunes or Stitcher. Tell your friends, leave a review.

Pethokoukis: Is the COVID-19 recession over? Are we done? Because we’re recording this as the May jobs report just released, and it kind of seems like the recession is over.

Strain: Well, I can only speak for myself. I expected a very bad report this morning documenting the state of the labor market in May, but I expected a good report four weeks from now documenting the state of the labor market in June. What’s happened, at least in my view, is that the labor market recovery began a month earlier than I had expected. And I think most economists had expected that as well. That’s certainly very good news. But to answer your question directly, I think we’re very far from this pandemic recession being over.

We have a 13.3 percent unemployment rate for the month of May. That’s a really terrible and devastating unemployment rate. The peak unemployment rate in the Great Recession occurred in the fall of 2009 when the unemployment rate hit 10 percent. So 10 percent was the Great Recession’s peak. We’re at 13.3 percent, which is over a third higher than the Great Recession.

So the labor market is improving. The improvement began about a month earlier than I would have thought, but the labor market is in really, really bad shape. And we’re in for that dynamic for several months. We’re going to see historic levels of job creation over the course of the summer. We’re going to see massive percentage declines in the unemployment rate. We’re going to see historic rates of GDP growth over the summer.

That sounds like a recession being over.

It sounds like a recession being over, but because the hole from the pandemic was so deep — because the devastation to the economy was so great — we need to have many, many, many months of tremendous progress in the labor market and the overall economy to dig ourselves out of the hole. So it’s going to be confusing. You’re going to see record rates of GDP growth and huge drops in the unemployment rate. You’re going to see that all summer long, I predict.

At the same time as that’s happening, the economy is also going to be in terrible shape in an absolute sense. Economists like to say, “Don’t confuse levels and changes.” The changes in the economy are going to be encouraging and they’re going to be big and they’re going to be in the right direction. But the level of economic activity and the level of unemployment is going to be really, really devastating.

Some of the forecasts were for unemployment at 20 percent or 25 percent — worse than the Great Depression. Why has unemployment not been at those levels? What has gone wrong with the forecast? Or maybe, what’s gone right with our response?

It’s a great question. First of all, it’s extremely difficult to forecast the path of this downturn and of this recovery. This is an unprecedented situation. Governors shutting down their states and issuing shelter-in-place orders (and that all happening over a period of a few weeks) really is unprecedented. And nobody really knows how that’s going to play out. Forecasting models take what’s happened in the past and try to use that to make informed statistical predictions of what’s going to happen in the future. But if you’re in an unprecedented situation, what’s happened in the past really gives you relatively limited insight into what might happen in the future. I think forecasting is just very, very difficult right now.

The other important thing about forecasting to remember is that when we have a report like we had this morning about the labor market, we’re all focusing on are net changes. So we say that 2.5 million new jobs were added in the month of May. That’s net new jobs. Underneath the hood, millions and millions and millions of people lost their jobs. Millions and millions of people also got hired, and the churn in the economy is enormous. The net changes are what we focus on at a time when gross changes are behaving unpredictably and differently. It’s awfully hard to predict net outcomes as well. So, there’s kind of a fog of war environment that we’re all operating in.

Do you think it was the virus or the orders that were the key catalyst for the economy going into a quarantine and all these jobs being lost? Do you feel like you have a good sense of which was more important?

No, I don’t have a good sense of which was more important. And that’s another really, really important reason why it’s hard to know what’s going on in the present, much less to forecast the future. There’s a debate: Are people staying home and not going shopping because they’re worried about getting sick or because the governor of their state has closed down a lot of economic activity — shops and restaurants and those sorts of things?

There’s evidence that the decline in economic activity in March happened before some of the shutdown orders took place, but of course there were all sorts of local measures that may have affected that. Just for example, it was very common for schools to close before the governor of that state issued lockdown orders. And so, people may have been shopping and eating out less because they were home with their kids, and not because they were worried about the virus. At the same time, I think a lot of people are worried about getting sick and that is leading a lot of people to stay home.

Certainly both are operative, and the question, I think, is which is more operative? We still don’t know the answer, but I do think that the state of the labor market in May really does give some weight to the hypothesis that the lockdown orders have played a big role here. Remember, this report reflected the labor market in mid-May, so a lot of lockdown orders were still in effect and places that were partially reopening were in the very early stages of partially reopening.

This suggests that when you lift the restrictions a little bit, you do see people returning to shops and returning to restaurants and that businesses are bringing workers back. That meshes with news reports, and it meshes certainly with my anecdotal observations as well. So, I think we still don’t know which is more important — fear of the virus or lockdown orders. But I think we do know that lockdown orders had at least some effect and that we can be confident that June’s labor market will look even better than the labor market in May because states will be more reopened.

We still have 21 million unemployed workers. How would you gauge the success of our response programs? There was expanding unemployment, so we sent checks. There was help for small businesses via the Paycheck Protection Program. How do you think they’ve done so far in keeping that unemployed number at 21 million and not 30 million or something?

I think that Congress’s response to this recession has been very, very strong, and I’ve been impressed by how well Congress has dealt with this problem. There’s a lot to quibble with in the CARES Act to be sure, but the basic approach, I think, is the right approach. The largest component of Congress’s response so far has been the Paycheck Protection Program, which has been aimed at supporting small business. That’s the largest in dollar terms, when you add in the subsequent bill that has supplemented its funding. That, I think, was critically important to supporting the economy at this time. Congress expanded unemployment insurance. That was the right thing to do, and it was also critically important. I think the size of the expansion was too generous, but expanding it was absolutely the right thing to do.

And Congress helped states with their Medicaid funding and did some other things as well, in addition to providing loans and other sorts of financing and options for large businesses and cash relief for households. Overall, I think Congress did a great job. People’s income increased enormously in April. The personal savings rate for the month of April was 33 percent, which is just enormous. So, we had a big hole in the economy that the pandemic and the shutdowns created: Households lost income, businesses lost revenue, there was a big hit to GDP. Congress did a very good job of filling that hole. That was important. I think it was also important to support small business continuity and to support workers. Congress did a good job with that too.

The Paycheck Protection Program wasn’t just trying to funnel money to workers through businesses. We wanted those workers to stay and attach to those businesses. And we wanted those businesses to stay intact so that on the other side of this pandemic-induced recession, we would have a small business sector that was operating and for workers to come back too.

Yeah, that’s exactly right. You wanted to keep workers attached to their employer, where they were working in February. That would reduce the unemployment rate, that would reduce pressure on state unemployment insurance systems, and that would allow the economy to snap back faster than would be possible if the unemployment rate climbed up into the 20-percent-plus range. You also wanted to keep those businesses intact so that unemployed workers had businesses that would hire them. If we lost all those businesses, then the unemployment rate would stay much higher for much longer because you would have to go through the process of business creation first, before there would be enough businesses around to hire unemployed workers. And of course there are many other things too.

These small businesses are able to be productive because they’re embedded in networks. They have good relationships with suppliers. They have good relationships with customers. They are rooted in their local communities. They figured out how to make money. They figured out how to provide goods and services that are valued. Losing all of that knowledge, losing all of that business-specific capital, losing all of those relationships, would be devastating to the economy and it would take years to recover. So it’s an important program. I think it’s very likely that the PPP program played a large role in the labor market recovery that we saw in May.

The program has distributed over $500 billion to small business. The average loan size is something like $160,000 as of late May. The number of borrowers totals 4.4 million. Over 99 percent of those loans were for less than $2 million. 79 percent of those loans were for less than a $100,000. And of the total dollars lent in the program, about $8 in every $10 were lent as part of loans, that’s for less than 2 million. As of mid-May, nearly 70 percent of small businesses received financial assistance from PPP. So this is going to a huge share of the nation’s small businesses. And in order for those loans to become grants, businesses have to spend a large portion of the money on payroll expenses. So I think it’s pretty likely that this program in particular really helped support the labor market in the month of May and is responsible for a lot of the good news that we’re celebrating today. Of course, that’s not the end of the story.

Indeed, one of the concerns that people have been bringing up is that we’re at the end of that program and all of these people who were state-attached are going to become unattached because the economy is still recovering. Rather than serving as a bridge to a stronger economy, they are concerned that this program is going to end up being a bridge to unemployment.

Yeah, that’s exactly right. And that’s one of many reasons why we shouldn’t conclude from the good news from this morning that we’re out of the woods. The program is set to expire, and the program shouldn’t just be renewed in its current configuration. The challenge facing the economy and the challenge facing Congress this summer is really a lot different than what we faced this spring.

The goal of PPP was essentially to freeze the small business sector in place where it was in February. And then, as you say, the PPP would create a bridge to the summer and unfreeze the economy, preserving as much of it as possible. Now that we are into the summer and the phase of this pandemic where all the states have reopened to at least some degree, the challenge is different.

And the challenge is harder. We don’t want public policy to unnecessarily impede the process of some industries growing, some industries shrinking, some firms expanding their payroll, some firms reducing their payroll. In order for the economy to get back to health, those sorts of adjustments need to take place. For example, it would not be good for the economy if the number of people who work for the airline industry is the same in August as it was in February. Or if the number of people who work in movie theaters is the same in August as it was in February. There’s going to be less demand for travel and there’s going to be less demand to go to the movies for many months, if not longer. And so for the economy to return to health, those industries need to shrink and other industries — like package delivery industry, for example — need to expand.

The same thing needs to happen within firms. If a restaurant can be profitable at 80 percent of its former workforce, then that restaurant should lay off 20 percent of its workforce and those workers should be supported through public policy to get new jobs. You don’t want that restaurant to have to keep its full complement of workers if that means it’s going to be unprofitable. So the next phase of small business support should allow for those types of reallocations to happen, while also providing businesses with some revenue replacements so that they don’t go out of business and that they can actually have the space to make those changes.

So what does that next phase look like?

Yeah. So I think it’s important to recognize — and this goes back to what we were talking about earlier about the difference between levels and changes — we’re going to see significant economic improvement every month for the next few months. The unemployment rate is going to drop quickly. GDP is going to recover quickly. But even if all the workers who are on temporary layoffs were rehired immediately and so the only problem we had were workers who have permanently lost their jobs, which is just the minority of job losses to date, we would still have recession-level unemployment. The unemployment rate would still be above 7 percent. We would still have lost a half decade of employment gains.

So this is a bad situation. And rapid improvement in a bad situation is good, but we’re still going to be in a bad situation come August or September, even if we rapidly improve in June and July. And that’s a message that’s important. It’s something that I think Congress needs to take very seriously.

Congress’s work is not done, right?

Their work is far from done.

But that work going forward shouldn’t just be, “Look at what we’ve done so far. Let’s just do more of that.” Right? It needs to be different.

Yeah. We need to do some things very differently. So small business support needs to look different. It needs to help businesses that are struggling, while also not stopping them from changing the way they produce goods and services or from shrinking their workforces.

So different requirements on that aid?

Different requirements on that aid. Unemployment insurance is going to look a lot different. Right now something like two thirds of workers who were eligible for unemployment insurance benefits would be getting a raise if they were unemployed, relative to what they would make in their jobs. That’s not good. It’s not a good use of taxpayer money, even during the shutdown. But from a macroeconomic perspective, it’s not terrible during a shutdown. But now that all the states have partially reopened and we’re moving toward a full reopening, that’s a serious problem. And that needs to change as well.

A big component of the CARES Act was checks to households. That was a fine thing to do, but I don’t know that we need to do that again. The CARES Act allocated $454 billion — that’s roughly 25 percent of all the money in the CARES Act — to the Treasury Department to support Federal Reserve lending programs. Hardly any of that capital has been put to work. Hardly any lending has taken place under those Fed programs. That money is just sitting there, and so the Treasury Secretary and the Treasury Department really need to put that money to work to support the economy. I don’t know that we would need any additional money for Fed lending in the next congressional package, because the Treasury Department hasn’t put any of the money to work that Congress appropriated in March. So that’s a big problem as well. I think we really do need another round of legislation.

How large should this next package be? About trillion dollars? And do you know what it would look like?

I’m not sure what the dollar figure for it should be, but I would be surprised if we need less than a trillion dollars of additional support. We know we’re going to need several hundred billion dollars just for small businesses. We know we’re going to need several hundred billion dollars to support workers who are unemployed. We know we’re going to need several hundred billion dollars to help fill the tax revenue hole that states are experiencing. So just some pretty quick back of the envelope math gets you in the ballpark of $1 trillion.

Where are we going to be in early September? We are going to be in a massive recession. We’re going to have one in 10 workers unemployed. The economy is going to be significantly smaller than it was 12 months earlier. We’re going to be in a situation in early September that is worse than the economy ever was during the Great Recession.

Those numbers sound like they’re worse than any numbers we’ve had since the Great Depression. Thirteen percent unemployment is a prewar number.

It’s going to be very bad. Yeah, that’s right.

Giving help to states and local governments seems to be a very controversial thing — while we’d like the private economy to roar, we don’t want our government to get too big and all that. But it sounds like that’s still a pretty important piece of this puzzle over the next three months.

Yes. I think that is an important piece. This is one of those debates on Capitol Hill where both sides are making really good points. Congressional Republicans are right not to want to use federal tax dollars to bail out state pension funds, many of which have been pretty poorly managed and are in bad shape. Congressional Democrats, and some Republicans as well, are right that it’s really important for the federal government to fill the hole in tax revenue that states are going to experience. Why is that important? It’s important because states can’t run deficits. If tax revenue plunges, and we saw this in the Great Recession, then states are going to have to lay off a bunch of workers. Well, that takes us in the wrong direction. We want the unemployment rate to come down, not to go up. And so there’s a really important role that federal aid to the states can play in keeping the unemployment rate down.

In addition, states have to do all sorts of stuff right now that costs money. School districts have to figure out how to handle reopening in the fall in the face of a potential second wave of the coronavirus. States have to spend more money on public health measures. And that spending is occurring at a time when their tax revenue is falling, so it really does mean that there’s even more pressure to lay off workers than would be the case in a normal recession. They may also just not provide some of those essential services as well as is needed, and that would be really bad too.

So the need here is very clear, but I think there should be some guard rails put around that money to make sure it doesn’t go to bail out pension funds. And I think that’s something that Congress should be able to handle.

So what will the economy look like six months from now? And how policy-dependent is your forecast?

Well, the economy six months from now is still going to be in very, very bad shape. It’s conceivable, I think, that the economy six months from now will have an unemployment rate of 8 percent. It’s also conceivable that the economy six months from now will have an unemployment rate of 10 percent. A lot really depends on how aggressive the virus is this fall. A lot depends on how state governments respond to that, with respect to social distancing measures. A lot depends on whether or not people’s desire to pull back from normal economic activity is driven by concern from the virus versus government-mandated lockdown orders. A lot depends on whether or not we have two months of social unrest around protests and concerns about racial equality or whether that only lasts a couple of weeks. There’s just a lot up in the air right now.

If people really do kind of rush back into normal life in the month of June, and if there’s a lot of pent up demand and people go out to dinner much more often than they normally would, and people do much more than they normally would, then the recovery is going to come back a lot faster. If people are more tentative and we have a couple more months of early steps like in May, the unemployment rate is going to be higher six months from now.

And so there’s just a lot of uncertainty, but policy has a huge role to play here. And I think we saw that in the employment report for the month of May. I suspect we’ll see it in the employment report for the month of June. Putting hundreds of billions of dollars into the hands of small businesses has done an enormous amount of good for workers, an enormous amount of good for the economy, and an enormous amount of good for those businesses. Putting hundreds of billions of dollars into the checking accounts of American households allows them to support the economy and get workers back to work faster.

If Congress should do something for state governments, you would see a similar proposition. The Fed’s programs have helped preserve the functioning of financial markets and to extend liquidity to large businesses as well. These fiscal and monetary policy measures have a huge impact on the course of economic recovery. And it’s just imperative that the good news from the May jobs report and the good news that we’re going to continue to see throughout the summer do not obscure the need for continued economic recovery legislation and economic recovery programs. If we lose that support, it will be a major setback for workers, for families, and for businesses.

My guest today has been Michael Strain. Mike, thanks for coming on the podcast.

Always happy to come on.

This article by James Pethokoukis and Michael R. Strain first appeared at the American Enterprise Institute.

Image: Reuters.