Right now the U.S. has a relatively small government: in a normal year the U.S. government as a whole spends something like 32% of total production. The U.S. government spends about ten percentage points less of GDP than the average rich, industrialized country spends. The U.S. government spends about 15 percentage points less of GDP than a never-Communist country as rich as the U.S. is today would be expected to spend. We are thus, in comparative perspective, a small-government country.

I think it is a safe bet that our government will and should spend a greater share of national income in the future. We have a "mixed economy"--neither overwhelmingly private nor overwhelmingly government, but a balance. In six areas government appears to do a better job than private--in defense, in basic research, in infrastructure, in education, in health insurance, and in old age pensions. There are also compelling reasons for government to redistribute income to compensate for the very important role that luck plays--most especially the luck in choosing the right parents--in determining lifetime income.

Recent attempts to move parts of education out of public and non-profit into the for-profit sector have been disappointing: the University of Phoenix and Stanley Kaplan University are an embarrassment. For 100 years we have been trying to maintain a market-oriented health-care system. This has given us a health-care system that costs twice as much as anybody else's and yet does worse in terms of infant mortality and life expectancy. When you are neck-and-neck with Cuba in indicators of national healthiness, something has gone wrong. We are trying again: starting on January 1 we are spreading the ideas that Mitt Romney had when he was Governor of Massachusetts about how to reform health-care finance and regulation across the country, and we will see how this round goes.

As for old-age pensions--well, Edward Filene was wrong: companies are not stable or long-lived enough to do the job with defined-benefit pensions. For the past generation we have been hoping that such "defined contribution" plans could do the job that employer-sponsored retirement pensions could not. But all Street appears to be quite good at figuring out how to make sure that a large chunk of 401(k) wealth flows to it rather than to the retiree. So attempts to figure out how to substitute the private market in traditionally public sectors have not been going well over the past generation.

Moving into a future in which we will need more infrastructure, benefit from more education, want more health care, and wish for more pensions because we will live longer than we do today, we will and should see government spending as a share of GDP rise gradually and modestly.

That is the long-run budget picture as I see it.

Now for the short run.

We ought to have about 63% of American adults at work right now. Instead we have 58.5% we have flatlined at 58.5% for nearly four years now. And that is not good.

Why is employment so low? Because production has collapsed relative to trend? Why has production collapsed relative to trend? Is it because we have run out of things worth making--either in aggregate or in particular sectors? No. It is because the pace of spending in the economy as a whole has fallen, and because wages and prices have not fallen in response--people really hate being told their wages are being cut, and so bosses tend not to do it. Why is the pace of spending lower? Starting in 2008 $8 trillion of assets that people had regraded as "safe"--AAA structured financial assets, mortgage-backed securities, the bonds of deficit-running European economies, etc.--stopped being seen as safe places to put your money. Ever since, banks and companies have been striving to build up their holdings of wealth in safe forms. As they try to do do, they try to cut their spending and investing below their income, but the economy as a whole cannot do that because where does one person's income come from but another person's spending?

On this diagnosis, the economy will not recover until and unless somebody--which right now means the government--creates enough safe assets for banks and businesses to not feel overleveraged anymore.

One road to making more safe assets would be for the government to guarantee private stuff--but that creates moral hazard: if the government is guaranteeing an investment, why should I care whether it is a sound investment or not? We would rather avoid creating moral hazard. The alternative is for the government to print up more bonds for people to hold--U.S. Treasury bonds are the ultimate safe asset--and do so by pushing taxes back from the present into the future and pulling spending forward from the future into the present. That's why I think it unwise to be cutting the government deficit right now. From my perspective, what the government needs is a bigger deficit right now and for the next several years.

Doesn't that create risks that the U.S. government will have too large a debt? Countries get into trouble with their debt when they owe the debt to somebody else in a foreign currency. We owe our debt in dollars. Countries also get into trouble with their debt when it carries a high interest rate. Right now interest rates on U.S. government debt are at record lows. It's not a problem--but if interest rates were to rise back to normal levels, that would be a powerful sign that it is time for the U.S. government to stop running a deficit, and I will then be the first person to call for budget surpluses--like I did at the start of the 1990s, when rising debt and large deficit were accompanied not by record low but by worrisomely high interest rates.

Right now the U.S. has a serious long-run economic problem: health care, old-age pensions, education, and infrastructure and R&D are all growing sectors, and we have not yet figured out how large we want them to grow, whether we want the government to maintain its current share of those sectors, and how the government will ultimately pay for any such growth. That is a serious, long-run economic problem: we have to solve it, but we do not have to solve it today or even by 2020.

Right now the U.S. has a desperately serious short-run economic problem. We ought to have 63% of our adults at work. We only have 58.5%. We really need to solve that problem right now, via formal and informal loan guarantees, via pushing taxes back into the future via pulling spending forward into the present, via having the government spend to put more people to work--at least until the U.S. government is no longer able to borrow at interest rates lower than have been seen in a millennium.