For instance, ECB staff uses a dynamic factor model that performs a trend/cycle decomposition of real activity and core inflation. 3 The model uses a single factor to capture common cyclical fluctuations and estimates the output gap as the deviation of output from its trend.
Different modelling assumptions, such as different sets of real activity indicators and different specifications of the trend components of the variables, lead to different estimates of the output gap. These differences are economically very relevant, with some models estimating an output gap that was close to zero in 2014 on average, and others estimating remaining slack of as much as –6%.