Since the Global Financial Crisis, a lively debate has emerged regarding the monetary policy rule the central bank of a small open economy (SOE) follows and should follow. By identifying the monetary policy rule that best fits historical data and minimizes central bank loss functions, this study contributes to this debate. We estimate a medium-scale micro-founded SOE model under various monetary policy rules using Israeli data from 1994 to 2019. Our results indicate that the model achieves a better fit to historical data when assuming inflation targeting (IT) compared to nominal income targeting (NGDP). Given central bank goals, shock uncertainty, and limited information, NGDP targeting rules may have been more desirable over the last three decades than IT rules.

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