[21] QE also exacerbates limits to arbitrage in foreign exchange markets, since it widens covered interest parity deviations reflected in the cross-currency basis, but not to an economically large extent. Chart 8 Decomposition of exchange rate response to a relative ECB-Federal Reserve QE shock (percentages)  Source: Dedola, L., Georgiadis, G., Gräb, J. and Mehl, A. (2018).
Notes: The figure presents the decomposition of the exchange rate response to a relative QE shock that increases the difference between the growth rates of the ECB's and the Federal Reserve's balance sheets by 1 percentage point into the UIP contributions accounted for by the response of the euro-dollar three-month money market rate differential (3mMM), the three-month CIP deviation (3m-CIP) as well as the expected exchange rate at each forecast horizon (Expected  exchange rate), according to a model discussed in Dedola et al.