Federal Reserve Faces Urgent Calls for Reform Amidst Reputation Crisis

As the term of the current chairperson of the Federal Reserve approaches its end in May 2026, the institution's reputation is at its lowest point in decades, and its vulnerability has reached an unprecedented level. This "institutional decay" is evident to any careful observer, even without considering the increasing risk to the political independence of the Federal Reserve. The challenges facing the Federal Reserve in achieving its dual mandate of price stability and maximum employment are becoming increasingly severe.

The current chairperson should not merely lament the situation that has led to the damage of the reputation of this most important central bank in the world, but should focus on doing everything possible to improve the situation for their successor. To understand the dire situation of the Federal Reserve, one only needs to read the recent commentary by the Secretary of the Treasury in the Wall Street Journal, who is widely regarded as the closest ally of the current chairperson in the Trump administration. After listing several mistakes made by the Federal Reserve, the Secretary called for an "honest, independent, and non-partisan comprehensive review of the entire institution, including monetary policy, regulation, communication, personnel allocation, and research."

This list is quite detailed. The Secretary also increased the intensity of the criticism through social media, accusing the Federal Reserve of exacerbating inequality and calling for a rate cut. These remarks are noteworthy and influential, not only because they come from the mouth of the current Secretary of the Treasury, but also because they accuse the top financial institution in the United States of widespread deficiencies and failures. Those who hold pessimistic views are not limited to the Secretary. More and more politicians and officials are joining the chorus calling for reform of the Federal Reserve, and these people are not all staunch supporters of Trump, but include the main candidates to succeed the current chairperson.

Reform of the Federal Reserve is indeed necessary. For the sake of the U.S. and global economies, reform should not be delayed until after the leadership transition. The current chairperson should respond to the call for reform immediately, even if it is difficult to correct major policy mistakes in the short term. After all, given that the annual inflation rate has exceeded the 2% target for five consecutive years, the current chairperson is highly unlikely to achieve the Federal Reserve's dual mandate of inflation control in the coming months. In addition, the economy may be deviating from the employment mandate, as multiple indicators (including recent reports and data revisions from the U.S. Bureau of Labor Statistics) point to a weakening labor market, and historical evidence suggests that such trends can accelerate in a non-linear manner.

The current chairperson is also unable to dispel the growing market concern about excessive risk-taking in the financial sector. Just this week, traditional "risk-seeking" and "risk-averse" assets simultaneously hit historical highs: U.S. stocks and gold rose together, credit spreads narrowed unusually, and the Bloomberg bond index rebounded sharply from its 2022 low into the "bull market" range. This abnormal combination is a warning signal, not only for Federal Reserve officials who focus on maintaining financial stability (the Federal Reserve's third, more implicit goal), but also for the emerging structural changes, including the wavering confidence of central banks around the world in holding dollars and U.S. debt, which, if continued, could weaken the global appeal of U.S. financial markets.

Although the current chairperson is unlikely to achieve the inflation or employment targets before leaving office, they can and should focus on solving other equally important economic problems. There is now a broad consensus that reform is needed to enhance the effectiveness of the Federal Reserve and restore its credibility. Reform is urgent because the Federal Reserve is finalizing its periodic monetary policy framework assessment, and judging from the mild opening at last month's Jackson Hole symposium, this assessment may repeat the 2020 assessment as a mere paper exercise. The current chairperson, whose term is in its final countdown, is facing a unique opportunity to help the Federal Reserve change course. The central bank is facing a multitude of problems, from cultural deficiencies and lack of accountability to communication errors, from refusing to acknowledge historical mistakes and inappropriate goal-setting to rigid group thinking. Fortunately, many examples from other central banks provide models for solving these problems.

Several commentators have proposed specific remedial measures. For example, a group of 30 highly respected former policymakers recently released a comprehensive roadmap containing reform recommendations. Several months ago, the author proposed a path that the current chairperson could have chosen to avoid the current political attacks on the entire Federal Reserve system (including regional Federal Reserve banks). The current chairperson did not take action, and the attacks have intensified. As the Federal Reserve's various mandates face the risk of failure, the current chairperson's continued inaction will cause the institution to suffer even greater damage. The past three months have had a significant impact on the Federal Reserve, and the impact of the coming months may be even more profound.