Mr Fayyad called for a Palestinian capital in East Jerusalem
Palestinian Authority Prime Minister Salam Fayyad has set a two-year target for the creation of a Palestinian state, in a speech in Jerusalem.
He reiterated the PA's demand that Israel freeze settlement activity in the West Bank before talks can restart.
Mr Fayyad accused Israeli PM Benjamin Netanyahu of trying to bypass Israel's commitments in a recent speech.
Mr Netanyahu backed a demilitarised Palestinian state, but said it must recognise Israel as a Jewish state.
"I call on all our people to unite around the project of establishing a state and to strengthen its institutions ... so that the Palestinian state becomes, by the end of next year or within two years at most, a reality," said Mr Fayyad.
He was critical of the lack of emphasis on the 2003 "Road Map" peace agreement, in which Israel agreed to halt settlement activity as part of a staged process towards the establishment of a Palestinian state.
No previous peace agreements have mentioned the recognition of Israel as a specifically Jewish state - something the Palestinians see as giving up what they see as the right of Palestinian refugees to return to Israel.
Speaking at al-Quds University in East Jerusalem, he stressed that the eastern side of the city "will be our eternal capital for our independent state".
This was a direct counter claim to Mr Netanyahu, who said the city, "Israel's capital" would remain "united".
Mr Netanyahu had been under heavy pressure from the administration of US President Barack Obama to back a two-state solution and stop settlement activity.
Mr Netanyahu says he will not create new settlements, but wants to continue building in existing ones to accommodate "natural growth" of the settler population.