Federal Reserve Chairman Ben Bernanke, an expert on the Great Depression, once promised that the central bank would never repeat its 1937 mistake of rushing to tighten monetary policy too soon and prolonging an economic slump.

He has been true to his word, keeping interest rates near zero since late 2008 and more than tripling the size of the Fed's balance sheet to $2.85 trillion. But cutbacks in government spending may end up having a similarly chilling effect on the economy, and there is little Bernanke can do to counter that.

Back in 1937, the U.S. economy had been growing rapidly for three years, thanks in large part to government programs aimed at ending the deep recession that began in 1929.

Then the central bank clamped down hard on lending, and federal government spending dropped 10 percent. The economy contracted again in 1938. The jobless rate soared.

Regarding the Great Depression. You're right, we did it. We're very sorry. But thanks to you, we won't do it again, Bernanke said back in 2002 at a conference honoring legendary economist Milton Friedman's 90th birthday.

Bernanke convenes the Fed's next policy-setting meeting on Tuesday, facing growing concern that the United States may be slipping into another recession while Europe staggers toward a deeper debt crisis. Standard & Poor's decision on Friday to lower the U.S. credit rating adds yet another element of uncertainty.

His options are limited.

Nigel Gault, chief U.S. economist at IHS Global Insight, said the Fed could promise to keep interest rates near zero or its balance sheet swollen for even longer than investors anticipate. Or it could buy even more U.S. government debt.

It is hard to see any of these options as 'game changers,' Gault said. The Fed would be doing them not because it could be sure they would make a huge difference, but because it would feel the need to do something.

Gault put the odds of another recession at 40 percent.

However, Friday's U.S. employment figures soothed recession fears, showing the economy created 117,000 jobs in July. That was up from a revised 46,000 in June and prior months payrolls were revised up slightly. The unemployment rate slipped to 9.1 percent but mostly because workers dropped out of the labor force.

While I do not think this sounds the all-clear signal, it does quell some of the conversation that the U.S. is falling back into a recession, said Tom Porcelli, chief U.S. economist at RBC Capital Markets in New York.

Having said that, there are still plenty of headwinds, like Europe. I am also very encouraged to see the upward revisions to the previous months. This report pulls us back from the ledge a little bit.

HITTING A POTHOLE

Full employment is one of the Fed's prescribed goals, and it is clearly falling short. Government spending cuts are making matters worse. Friday's employment report showed a net loss of 37,000 government jobs last month.

State and local governments with balanced budget rules had little choice but to cut jobs in order to make ends meet. The federal government has no such restriction, but its spending outside of defense fell at a 7.3 percent annual rate in the second quarter, crimping economic growth.

Michael Feroli, an economist with JPMorgan in New York, said he had held out some hope that Congress would approve some form of additional fiscal support in the coming months, but the debt ceiling fight showed lawmakers dead set against that.

It now looks likely that growth could hit a pothole early next year, Feroli said.

He cut his growth forecast for the first half of 2012 to 2.0 percent from 2.5 percent. At that sluggish pace, the jobless rate won't fall much below 9.0 percent, keeping the Fed on hold until at least the middle of 2013, Feroli said.

Without fiscal help, the Fed will be under greater pressure to find some other way to lift growth. Another round of government bond purchases would no doubt elicit wails of protest from emerging markets, which contend that the Fed's easy money spills into their economies, driving up inflation.

China, whose $1.16 trillion in Treasury holdings are second only to the Fed's, has not been shy about expressing its concern over the state of U.S. public finances and the dollar's slide.

Yang Jiechi, China's foreign minister, said on Friday that Washington should enact responsible monetary policies to ensure global economic stability, a thinly veiled reference to the Fed's bond-buying programs.

China releases its monthly economic data this week. The figures are expected to show double-digit gains in industrial output and retail sales, suggesting the country's economic growth remains robust.

Strong growth in China has helped to lift the rest of Asia, outside of Japan, which is still hurting from the March earthquake and tsunami. But all bets are off if conditions worsen significantly in the United States.

Our view is that the region can 'decouple' from modest slowdowns, and we think the ongoing slowdown qualifies as modest, said TJ Bond, emerging Asia economist at Bank of America-Merrill Lynch in Hong Kong.

We would start to worry if the U.S. tipped over into recession.

(Editing by Dan Grebler)

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