Suppose that the U.S. government budget deficit decreases. What curves in the open-economy macroeconomic model shift? Explain why each curve shifts the direction it does.

The supply of loanable funds curve shifts right because a reduction in the deficit raises national saving which is the source of the supply of loanable funds. As the supply of loanable funds shifts right, the interest rate falls. This decrease in the interest rate causes the quantity of net capital outflow to rise, which means that U.S. residents will supply more dollars in order to purchase more foreign assets. So the supply of dollars in the foreign-currency exchange market shifts right.