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Chaotic Greek Economy Spells Trouble for Euro zone

European Central Bank chief Jean-Claude Trichet described talk of Greece and other weak states being expelled from the euro zone as ''absurd hypotheses.''

 Greece's debt and deficit crisis is placing increasing pressure on the stability of the euro, the common currency of the 16-nation euro zone bloc.

A meeting of governors of the European Central Bank (ECB) in Frankfurt on January 14 addressed the problem posed by Greece's runaway budget deficit in what the media are calling the worst crisis since the euro was introduced in 1999.

ECB President Jean-Claude Trichet described talk of Greece and other weak states being expelled from the euro zone because of fiscal problems as "absurd hypotheses."

But he added that "there is a lot of hard work to do. And you can see to what extent the governing council has been figuring out the necessity to have appropriate measures and appropriate implementation of the measures as regards fiscal policy.

"This is absolutely key. This is key for all countries and we have a message for all members of the euro area. It is also very important for some of them which have a special difficulty. It is for their own prosperity, for their own recovery that they have to redress the situation in taking appropriate, bold and courageous measures."

Simon Tilford, chief economist at the Center for European Reform in London, says that the case in particular of Greece poses a significant challenge to the euro zone.

"On the one hand, they can't let Greece get away with pursuing unsustainable policies; on the other hand, at the same time they can't be too tough with the Greek government, because there is only so much the Greek government can do, there is already risk of social instability in Greece," Tilford says.

Greece In Trouble

There have been fears that the other euro zone members will have to come to the rescue of Greece, which has admitted it has a government debt of a massive 12.5 percent of gross domestic product (GDP) -- some three times higher than was originally estimated by the previous government in official statistics early in 2009.

Aware of the national embarrassment his country is suffering, Greek Prime Minister George Papandreou on Thursday announced a new economic plan to bring the ballooning deficit within the 3 percent of GDP required of eurozone members, by 2012.

Papandreou has said he will not seek a bailout from other European Union states, nor will he seek financial support from the International Monetary Fund (IMF). Both options would entail loss of face as they would be an admission that Athens could not handle its current problems without outside help.

In fact, there is an IMF team presently visiting Athens, but Greek officials say they are only there to offer advice, not to prepare a rescue package.

But economists say sticking to Papandreou's plan will require severe austerity in public spending, and they question whether this can be done in Greece -- one of the European Union's poorest members -- without provoking public unrest. It also appears to conflict with socialist Papandreou's pledge to return the country to health without penalizing the poor.

Analyst Tilford sees no "chance at all of Greece being able to reduce its deficit as quickly as they are suggesting; with growth prospects so poor, with demand for their exports set to be so weak," which he attributes to Greece becoming uncompetitive within the euro zone, as well as the strength of the euro itself.

He says this means that "their exports both inside and outside the euro zone will be weak --- private consumption is going to be weak, if you then add big cuts in government spending, big cuts in real wages to reduce costs relative to other euro zone members, I think there is a real risk of a slump."

Threat To Euro Solidarity?

All this disorganization has the potential to undermine the credibility of the euro, which has been remarkably steady during the last two years of international financial turmoil.

The Frankfurt meeting of ECB governors decided to leave unchanged the basic interest rate at the historic low of 1 percent. This is very much a compromise that illustrates the differing pressures that could theoretically grow so strong as to rupture the euro pact between participating countries.

The low interest rate is needed by Greece, Ireland, Spain and Portugal to stimulate growth in their near-paralyzed economies. But it could fuel inflationary tendencies in the stronger euro zone states, such as Germany and France, which have emerged from recession and are growing again.

The ECB governors obviously judged the inflationary tendencies to be still quite small in the recovering economies. But should strong growth return, the mismatch of the super-low interest rate to those conditions will become obvious and dangerous.

When originally conceived, the euro was meant to join together economies that were relatively at the same level of development. This would make possible a "one size fits all" interest-rate policy. But subsequent reality has shown this to be overly optimistic.

One option would be for the euro zone to simply jettison those members that cannot live up to the conditions imposed by the ECB. But Trichet ruled that out categorically.

And responding to hints that Athens should withdraw from the euro zone, Papandreou has firmly rejected that possibility. No mechanism exists for countries to resign from the zone, and politically it would be a very difficult decision for the European Union to take.