Federal Reserve Bank of Chicago President Austan Goolsbee warned Monday that a credit tightening is under way and recession is a possibility.

“The credit crunch or at least the credit squeeze is beginning,” Goolsbee told Yahoo Finance LIVE in an exclusive interview, when asked how he views credit conditions in light of several bank failures over the last two months.

The comments from Goolsbee follow his vote last Wednesday to raise the Federal Reserve's policy rate by a quarter point.

Goolsbee is concerned that a lending slowdown is happening just as an argument over raising the nation's debt limit comes to a head. President Biden and House Speaker Kevin McCarthy are scheduled to sit down Tuesday to discuss ways to avoid a default on the country's debt that could come as early as June 1.

“I think you have to say that recession is a possibility,” said Goolsbee, cautioning: “You do not land the plane nose down."

He says the Fed needs to take the recent bank stresses and credit conditions into account when setting monetary policy, though it’s too early before the next meeting to say whether to take a pause.

“We have to figure out how much of the work of monetary policy is getting done already through the credit conditions, and we have to be mindful that that's not going to be evenly distributed around the country,” he said.

He said he will be paying attention to a senior loan officer survey released by the Fed on Monday that showed a slower pace of lending and tightening standards from banks as turmoil roiled that industry during the first quarter.

The job market, he said, is another major area of scrutiny for the Fed. He said he likes to scrutinize the job market over three months, and focus on the total hours worked by everyone in the economy, not just the number of jobs.

Total hours worked, he says, has not been as robustly growing as overall job growth would suggest. “Given what's happening with the jobs, it does look like that is cooling the froth off the top of it,” he said.

Debt ceiling argument comes at 'worst possible time'

Gooslbee has been through a debt ceiling fight before.

When he served as chairman of the Council of Economic Advisers under President Barrack Obama, he witnessed a standoff between Republicans and Democrats over tying spending cuts to raising the debt ceiling.

The new argument, he said, comes “at the worst possible time.”

“We're trying to figure out what is a very strange business cycle coming out of the pandemic, and weighing that against the tightening that's coming from these bank failures and uncertainly, and to add on to it this uncertainty about whether the government is going to pay its bills,” says Goolsbee.

He says a lot of potentially “weird things” could happen in financial markets if lawmakers’ negotiations go down to the wire before clinching a deal.

“I'm worried about things like are we going to reignite a bunch of banking stresses where financial institutions have Treasuries as their collateral,” says Goolsbee.

“On the consumer side, you would see interest rates going up on mortgages, on auto loans, on credit cards, a whole bunch of things that are in directly tied to the rates on Treasuries. I think you would have a lot of chaos.”

Goolsbee said lawmakers have to raise the debt ceiling. “There isn't another alternative. So let's hope they can get that message.”

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