Throwing the rule book at Greece

European crisis management is often a messy process, which does not make comfortable viewing for the faint-hearted – but the end results can be positive.

Financial market reaction to Monday night’s vows of fiscal restraint by George Papandreou, Greece’s prime minister, has been negative, but not yet disastrous.
The European Union’s leaders – and government bond investors – have pushed Athens closer to a credible strategy for bringing Greece’s Olympus-sized deficit back under control. Although details were missing, Mr Papandreou pledged to bring the deficit back below the EU limit of 3 per cent of gross domestic product by the end of 2013.

The latest moves were “steps in the right direction”, said Joaquín Almunia, EU economics affairs commissioner.

For Brussels, that was a fair result after a scrappy few weeks during which it has been unclear exactly where Europe’s leaders stood.

Since statistical revisions led the European Commission last month to revise sharply upwards its forecasts for the Greek public deficit, financial markets have speculated whether the threat of default would throw Athens at the mercy of the International Monetary Fund or if other EU countries would intervene first.

Heightening the tension, Greece is not only an EU member but also a long-standing member of the eurozone, Europe’s 11-year-old monetary union.

The response of other eurozone finance ministers and the European Central Bank has been one of “constructive ambiguity” – piling pressure on Athens by leaving unclear exactly what would happen in the worst case.

Jean-Claude Trichet, the ECB president, for example, simply expressed “confidence” that Athens would take the right decisions, which he said would have to be “courageous”. If the strategy was deliberate, it gave a good impression of being improvised.

Mr Trichet highlighted fears of “moral hazard” – rewarding irresponsible behaviour by governments. There is also concern that the eurozone sticks to its rules and procedures. With no single political authority, the monetary union has to operate as a “rules-based” system, the argument goes.

In Greece’s case this means following procedures under the EU’s stability and growth pact, which could eventually lead to sanctions for repeated breaches of the 3 per cent deficit limit.

The eurozone’s architects hardly envisaged an economic crisis on the scale seen in the past two years. But whereas US and UK policymakers threw away the rule books to combat the recession, the pact has remained an important touchstone; eurozone policymakers would rather throw the rule book at Greece.

Overriding such considerations, however, is a desire to preserve the spirit of European economic integration, which has been knocked by the financial market crisis.

The euro’s launch in January 1999 was the most successful integrationist step so far. Even if the Greek default were containable, the political repercussions would spread. “What happens in one member state affects all the others . . . which means we have a common responsibility,” admitted Angela Merkel, Germany’s chancellor.

The results of trying to drive forward economic integration, while sticking to the rules, are sometimes perverse. Many Germans would argue Greece should never have been allowed into the eurozone, given that we know now its public finances have rarely fallen within the stability and growth pact’s limits. But Baltic countries still smart over how in 2006 Lithuania was barred from joining the eurozone because its inflation rate exceeded the threshold – by just 0.07 per cent.

Comfort will be taken from signs that “constructive ambiguity” vis-à-vis Greece is having an effect. Outside pressure will help Mr Papandreou as he seeks domestic political and – crucially – trade union support for an unappetising austerity package. A beneficial side-effect is that the uncertainty over Greece has weakened the euro, helping hard-pressed eurozone exporters.

However, such relief does not make eurozone crisis management methods less awkward – or risky.