As we approach the end of 2025, the Federal Reserve finds itself at a crossroads. Mortgage rates remain stubbornly high at around 6.8 percent, despite multiple rate cuts this year. Market expectations for the December 18 meeting have whipsawed dramatically, with the probability of a quarter-point cut fluctuating from 90 percent down to 30 percent and back up to 87 percent in just four weeks. Meanwhile, in the most recent Federal Open Market Committee vote, six of the 19 members dissented against any cut at all, even as job growth shows signs of softening.
For the first time in decades, a rare consensus has emerged across the political spectrum, from President Donald Trump’s economic advisors to mainstream economists like Mohamed El-Erian and even some retiring Fed insiders, that the institution is fundamentally flawed. The Federal Reserve, as currently structured, is broken, and 2026 is shaping up to be the year of its most significant overhaul since Paul Volcker’s anti-inflation crusade in the 1980s.
This isn’t hyperbole. The calls for reform stem from a series of high-profile failures that have eroded public trust, stifled economic growth, and left ordinary Americans grappling with unaffordable housing and borrowing costs. With Jerome Powell’s term as chair expiring in May 2026, and Trump poised to nominate a successor as early as January, the stage is set for profound changes. Treasury Secretary Scott Bessent has already begun convening quiet working groups to explore these ideas, signaling that the new administration views Fed reform as essential to unlocking 4 to 5 percent annual growth through deregulation, energy expansion, and tariffs. But what exactly went wrong, and what reforms are on the table? This article delves into the details, drawing on recent statements from key figures and the broader economic context.
The Five Failures That Created the 2025 Consensus
The Federal Reserve’s troubles didn’t emerge overnight. They are the culmination of systemic issues exposed by the post-pandemic economy, artificial intelligence disruptions, and geopolitical shifts. Here are the five core failures that have galvanized demands for change.
First, the Fed’s forecasting has been a catastrophe. In 2021, officials dismissed inflation surging to 9 percent as “transitory,” only to embark on the most aggressive rate-hiking cycle in decades. By 2023, they predicted a recession that never materialized, thanks to resilient consumer spending and supply-chain recoveries. Fast-forward to 2025, and the Fed’s models still peg potential U.S. growth at a meager 1.8 to 2.0 percent annually, even as AI productivity gains and energy booms suggest the economy could expand much faster without overheating. This isn’t just academic; bad forecasts lead to bad policy. As El-Erian noted in a December 2 Fortune interview, “This Fed went to sleep,” allowing complacency to undermine its credibility. Critics argue that the Fed’s reliance on outdated dynamic stochastic general equilibrium models, which prioritize backward-looking data, blinds it to forward-looking innovations like AI.
Second, the Fed’s demand-side obsession has become a religion. Its core framework assumes that any growth exceeding about 2 percent risks spiraling inflation, prompting reflexive rate hikes to cool demand. This “speed limit” mentality, rooted in 1970s Keynesian ideas, clashes with the supply-side realities of 2025. For instance, Trump’s plans for massive energy production and $18 trillion in foreign investments could boost supply and lower prices, yet the Fed’s models would interpret faster growth as inflationary. Kevin Warsh, a former Fed governor and shortlist candidate, lambasted this in a November Wall Street Journal op-ed, calling the Fed “an obstacle to stronger economic growth” and criticizing its role in perpetuating a “housing recession.” David Malpass, another Trump advisor, echoes this, arguing that the Fed’s anti-growth bias will hinder the administration’s agenda into 2026.
Third, rate cuts haven’t reached Main Street. The Fed has trimmed its benchmark rate four times since September 2024, bringing it to 4.25 to 4.50 percent by December. Yet, 30-year mortgage rates remain elevated at 6.5 to 7 percent, pricing out first-time buyers and stifling the housing market. This disconnect arises because long-term rates are influenced by global investor expectations, not just Fed actions. Warsh has pointed to this as evidence of the Fed’s failure to build trust in a stable dollar, while El-Erian warns that without reforms, affordability crises will worsen, especially for lower-income households already cutting back on essentials.
Fourth, communication has devolved into daily market chaos. The Fed’s “dot plot”, a quarterly graphic showing anonymous rate projections, fuels speculation and volatility. Combined with Chair Powell’s press conferences and leaked comments, it turns monetary policy into a spectacle. El-Erian described this as “almost absurd” in his December 1 CNBC appearance, highlighting how forward guidance, meant to provide stability, instead amplifies uncertainty. Businesses delay investments, and markets swing wildly, as seen in the recent December cut probability gyrations.
Fifth, credibility has collapsed due to internal scandals and groupthink. Ethical lapses, including 2021-2022 trading controversies among officials, have damaged the Fed’s image. Internally, a compliance culture that prioritizes consensus over debate has led to policy inertia. Retiring Governor Loretta Mester admitted as much in recent remarks, saying the Fed must address its mistakes. Even Bessent, in a December 5 speech, criticized the institution’s handling of systemic risks, calling for broader oversight reforms. These failures have politicized the Fed, with Trump accusing it of partisanship and vowing to appoint a chair who prioritizes “honest interest rates.”
The Seven Concrete Reforms Already on the Table
With these failures in mind, reformers are not waiting for 2026. Discussions are underway, informed by think tanks like the Hoover Institution and private sector input. Here are the seven key proposals gaining traction, each with its champions and implementation details.
- Kill or gut the dot plot and forward guidance. Bessent and El-Erian have publicly demanded an end to this “kindergarten guessing game,” arguing it exacerbates volatility. Kevin Hassett, the frontrunner with 78 to 84 percent odds in prediction markets like Kalshi and PredictIt, supports replacing it with simpler, rule-based communication, such as tying rates to explicit economic thresholds. This could be enacted via a formal FOMC vote in early 2026.
- Replace point forecasts with scenario planning. Instead of single-number predictions for GDP or inflation, the Fed would publish multiple “what-if” paths, incorporating uncertainties like AI disruptions or tariff impacts. Mester and El-Erian champion this, with Hassett already piloting similar approaches in some regional Fed banks. Warsh, in his July Hoover podcast, called it essential for adapting to a “regime change” in economics.
- Force the supply side into core models. AI productivity, energy supply, immigration flows, and tariffs must become first-order variables. Malpass and Hassett push this hardest, criticizing the current assumption of perpetual 1.8 percent potential growth. El-Erian’s November Project Syndicate piece hopes the next chair will “shake the institution out of complacency” by integrating these factors, potentially allowing hotter growth without hikes.
- Re-examine or soften the 2 percent inflation target. Options include allowing temporary overshoots, averaging 2 percent over cycles, or switching to nominal GDP targeting. Warsh and Hassett have authored papers on this, with Warsh arguing in April Reuters comments that the Fed has “left its lane” by rigidly pursuing the target at the expense of growth. This reform could be part of a 2026 framework review.
- Reduce the automatic hawkish voting power of regional presidents. Six relatively hawkish presidents rotate off the FOMC in 2026 and 2027, creating a natural dovish tilt. Bessent is drafting ways to further limit their influence, such as rotating votes more frequently or prioritizing board governors. Hassett views this as key to preventing internal gridlock.
- Implement a staff and culture purge with new expertise. Hassett plans 20 to 30 percent cuts to the research staff, bringing in AI and supply-side specialists. This addresses groupthink, as El-Erian emphasized in his December LinkedIn post: “We desperately need reforms.” Bessent’s recent FSOC overhaul proposals signal a broader cultural shift toward accountability.
- End the $3 trillion “bank subsidy” through interest on excess reserves. Currently, banks earn 5.4 percent on trillions parked at the Fed, distorting markets. Warsh and BlackRock’s Rick Rieder advocate phasing this out to free up capital and lower long-term rates, aligning with Trump’s push for affordable mortgages.
The Political and Calendar Reality: Why 2026 Is the Tipping Point
Timing is everything. Jerome Powell’s term as chair expires on May 15, 2026. That single date hands the incoming Trump administration a once-in-a-generation opportunity to install a new leader and launch sweeping changes without needing Congressional approval for most operational reforms.
The calendar is unusually favorable:
- Trump’s interviews with finalists (Warsh, Hassett, Waller, Bowman, and Rieder) are already underway. Markets and insiders expect an announcement between mid-January and early February 2026.
- The Senate confirmation process could be completed by April, giving the new chair a full year to execute before the 2026 midterms.
- Six of the more hawkish regional Fed bank presidents (considered the most skeptical of fast growth) lose their automatic FOMC voting seats in 2026 and 2027, replaced by a mix of Trump-appointed governors and more dovish regional leaders.
- Treasury Secretary Bessent confirmed in a December 10 Bloomberg interview that “working groups are meeting weekly” to prepare reform packages, ensuring the new chair hits the ground running.
This convergence of expiration dates, personnel turnover, and political will makes 2026 the perfect storm for change.
The Stakes: Two Radically Different 2027 Americas
The outcome of these reforms will define the economic lives of millions of Americans. Here are the two plausible futures.
The Success Scenario (Reform Wins)
Mortgage rates fall sustainably below 5 percent as global investors regain confidence in a supply-friendly Fed. Potential growth estimates are revised up to 3.5 percent or higher, giving the administration room to run the economy hot without immediate rate hikes. AI-driven productivity gains compound with energy abundance, delivering real wage growth for the bottom half of earners for the first time in two decades. Treasury borrowing costs drop, easing pressure on the deficit. By late 2027, the phrase “soft landing” feels quaint because the economy is in a sustained 4-plus percent growth territory.
The Failure Scenario (Reform Stalls)
The new chair is blocked or watered down by Senate Democrats or internal resistance. The old guard on the FOMC keeps its voting power. Models remain stuck in the 1.8 percent speed-limit world. Rate cuts stay timid, long-term yields refuse to fall, and mortgage rates stay above 6 percent into 2028. Housing remains unaffordable, small-business lending stays frozen, and the 2026 midterm elections become a national referendum on “why nothing ever gets cheaper.” Political pressure mounts for even more radical solutions, potentially Congress stripping the Fed of independence altogether.
Most insiders believe the first scenario is now the base case. Hassett’s 84 percent odds in prediction markets reflect that confidence.
Closing: A New Era for Monetary Policy
The Federal Reserve spent forty years perfecting tools to fight the inflation of the 1970s and the demand shortages of the 2010s. It is now entering a world defined by AI abundance, energy dominance, and supply-side shocks, both positive and negative. The institution that emerges in 2026 will either adapt and become an enabler of American prosperity, or it will cling to the past and become the biggest domestic obstacle it faces.
2026 is not just another leadership transition. It is the year the Fed is finally dragged, willingly or not, into the next economic war. The only question left is whether it arrives armed with new weapons or still carrying the old ones.
