The theory and practice of central banking has changed markedly in the past quarter century, in parallel with advances in macroeconomics that draw on the rational expectations approach and on game theory, and in response to the inflationary experiences of the 1970s and 1980s and the accumulation of evidence on the nature of the Phillips curve.

These changes have already had a major impact on central banking in Israel. This lecture, in memory of Don Patinkin, mentor and friend of so many of us here this evening, presents an occasion for a systematic statement of the current approach to monetary policy and the role of the central bank in Israel, and some of the academic work and evidence on which it is based.

In discussing modern central banking I shall take up: first, central bank independence; second, the inflation targeting approach to monetary policy; and third, the institutional arrangements most conducive to the success of the central bank. Of course, my discussion will relate to Israel and to changes proposed in the draft Bank of Israel law. I should note though that I will focus on monetary policy, and not on other aspects of the work of the Bank of Israel, including bank supervision and the role of the Governor as economic adviser to the government.

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