A country ASDF likes to fight wars (sometimes) and smooth consumption. It has a GDPof $1 trillion ($1000 billion) every year. It is year 0 and ASDF has zero external wealth W = 0 initially (inherited fromyear-1). The world real interest rate is 5%.

If there is no war (peacetime) country ASDF consumes all GDP, and never invests, with C = GNE = GDP in all future years, and I = G = 0. However, country ASDF starts a war in year 0. Fighting a war costs G = $84 billion per year.

The Long Run Budget Constraint (LRBC) must hold. Assume there are no capital gains or capital transfers, KG = KA = 0, so the change in W each period is exactly equal to CA.

1. Let us assume that, at first, the people in country ASDF think the war will last only 1 year. Under that assumption, how much will they borrow in year 0 to finance the war? How much do they cut their consumption?
2. Treat the events in year 0 as given above in part a. Now in year 1, country ASDF find they can not exit the war, and they now update their beliefs and think the war will last 1 more year. How much extra should they borrow at this point? How much more do they cut consumption?
3. The same thing happens in years 2, 3, and 4. How much more do they borrow and how do they cut their consumption each time?
4. Now suppose country ASDF had known the war would last 5 years (year 0 -> year 4) from the very beginning in year 0. Would they have chosen this consumption path? why or why not?
5. It turns out that the rest of the world will not lend unlimited amounts to country ASDF. IN FACT the debt limit for country ASDF is 80% of their GDP or $800 billion. How long a war can country ASDF afford to fight using external finance to smooth consumption when it proceeds as above (in parts a/b/c), extending the war one year at a time?