The looming recession will stop short of a full-blown financial crisis because the Fed is still in control, ex-NY Fed chief Bill Dudley says

"This is a recession where the Fed has the controls. When they need to ease, they can do so," former New York Fed President Bill Dudley said.

• A looming economic recession won't spiral into a full blown financial crisis, according to ex-NY Fed chief Bill Dudley.
• That's because the recession, which is "pretty likely" according to Dudley, will be induced by the Fed.
• "I think this is a recession where the Fed has the controls, when they need to ease they can do so," Dudley said.

A looming economic recession is "pretty likely," according to former New York Fed President Bill Dudley, but that doesn't mean what some investors might expect.

While previous recessions have been associated with a deep and prolonged period of economic pain, like in 2008, this time around the Fed has its hands on the wheel.

"What's different this time I think is that if we have a recession, it's going to be a Fed-induced recession and the Fed can end the recession by subsequently easing monetary policy," Dudley told Bloomberg on Monday.

In other words, while the Fed has been raising interest rates to tame inflation and slow down the economy, it can do the exact opposite and swiftly cut interest rates to help stimulate the economy in the event of a downturn.

"The Fed has to drive up the unemployment rate efficiently to slow down the economy to generate slack in the labor market and bring wage inflation down to a level of consistent 2% inflation," Dudley explained. "This is a recession where the Fed has the controls. When they need to ease, they can do so."

The big challenge for Fed policymakers will be the timing of monetary policy decisions, as they don't want to cut interest rates too soon and risk inflation re-accelerating and gaining momentum — or too late and risk creating a painful recession.

"The challenge for them is to not ease too soon, but to ease in a timely way," Dudley said. 

And if they manage to do that, the Fed can avoid a systematic financial crisis that leads to instability during the next recession. And that's not unheard of despite the painful and lasting memory investors have of the 2008 Great Financial Crisis. 

Since 1950, the average recession has lasted just 10 months and resulted in a GDP contraction of 2.5%, with nearly 4 million jobs being erased. For reference, the US economy added more than 4.3 million jobs in 2022.

"I don't think that there's a big risk of a financial-instability cataclysm that pushes the economy into a deep recession," Dudley said. That would be a welcome relief to investors who are still scarred by the doomsday environment that was 2008 and 2009.