Microeconomic evidence suggests price changes are either very small, or large. The theory of inferential expectations predicts this phenomena if agents use a low test size, reflecting a reluctance to change their minds on the basis of evidence

We incorporate inferential expectations into the Barro-Gordon model (1983a) of time inconsistency and consider reputational equilibria. The range of sustainable equilibria shrinks as the private sector becomes more belief-conservative

We propose that the formation of beliefs be treated as statistical hypothesis tests, and we label such beliefs inferential expectations. If a belief is overturned through the build-up of evidence, agents are assumed to switch to the rational expectation. Rational expectations are shown to be a...