The Harrod-Domar economic model was developed after the Keynesian model for explaining economic growth. The Domar problem was based on the assumption that an economy should not grow to full employment based on such beliefs that the labor price and capital are fixed. Therefore, the model spells the problem with the assumption of economic growth equals economic development. An increase in investment would result in an increased demand, but according to the Domar problem, no guarantee would exist to ensure that the additional demand created through higher investments would be absorbed by the additional capacity created (Wray 3). While the Harrod-Domar model supports borrowing undertaken by the poor countries for investment, it failed to explain the expected challenge that would be experienced during the repayment period. According to the article by Wray, borrowing from the “big bank” by the “big government” was essential for facilitating growth, but would not explain how the extra demand to be created would be served. The problem of large budget deficits as currently experienced by the US would be explained by the Domar problem of higher borrowing by the government as shown by Wary.
If the United States were to overcome the challenge of huge budgetary deficits as experienced currently, then the “Domar problem” would have to be overcome. As argued by Minsky, the government would overcome the challenge by triggering a rise in the aggregate demand of the economy and thus overcoming the cyclical budget deficits experienced over the years (Wary 21-22). With surplus created during the boom, then the economy should be stable during the seasons of low production. The government would encourage higher economic activity through higher rates of repayment of interests and increasing transfer payments. Increased government spending would create more money for the circulation, and that would trigger higher productivity. As such, the problem of high budget deficits as currently experienced would be reduced by the decrease of government borrowing as more finances are injected into the cycle by improved production rates in the economy.
Wray, L. Randall. “Demand Constraints and Big Government.” 2007. Web. 18 Nov. 2015. <http://www.levyinstitute.org/pubs/wp_488.pdf>.