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EU Searches For Political Answer to Economic Problem

The European Union is wrestling with complex political considerations as much as economic ones that are likely to play a pivotal role in the timing and shape of any aid package to resolve the Greek debt crisis, experts say.

As a result, a rescue package is a near certainty—despite questions about its legality—because Europe’s greater and long-term goals require keeping economic and monetary union intact.

"The short-run concern is the Greek situation might create distress that could affect financial markets of the whole area," says Domenico Lombardi, a G7 expert at the Brookings Institution. "In the long run, there's this broader concern that letting Greece fail could jeopardize the whole idea of an ever-closer union."

While Germany may fall into the first camp, and The Netherlands the latter, "all [members] want to see a way out for Greece," Lombardi says.

Experts cite a central ambiguity in Europe, wherein economic and monetary cooperation has become acceptable, but anything else—especially on the political side—is kept at a safe distance.

“I think if you take a step back, monetary union is what keeps Europe together,” says Michael Werz, a senior fellow at Center for American Progress who studied and taught in Germany before coming to the U.S. “The E.U. was successful as long as it was largely an economic one with a degree of the political.”

That may help explain the quirkiness, even inconsistencies, of EMU. Though the union requires new members to meet rigid economic, monetary and fiscal criteria—as well as share a currency—there are no contingencies for crises such as the current one. 

For all the speculation about Greece falling out of the union, there is no existing exit mechanism. The European Central Bank has no bailout authority in its charter. The ambiguity, however, is clear in emergency powers allowing financial help if a crisis warrants it.

"All those criteria were set for entry. Once you're in you're in for good," says Ram Bhagavatula, managing director at Combinatorics Capital. "In a sense all solutions are to be considered in that context."

The Greece crisis also comes at an untimely moment for the EU, which has new leadership that some say has yet to prove itself. That explains why much of the policy talk is coming from Berlin and Paris, the capitals of its biggest and richest members, and not Brussels, home of the E.U.

Thus far, that talk has been murky and conditional, but will no doubt become more focused at the E.U ‘s informal summit Thursday.

Some have compared the Greece debt crisis—as well as its probable rescue response—to the Mexican peso crisis of 1994, which was quickly addressed by a joint U.S.-IMF loan package.

“We'll give you a loan and you get your fiscal house in order,” says Bhagavatula, explaining the central quid pro quo of the deal.

Unlike Mexico, however, Greece cannot devalue its currency, and some of its corrective steps are bound to have ramifications for other Euro members, particularly those with similar, though less dire, debt problems.

Some say neither the E.U. nor the IMF should act and simply let market conditions force Greece’s hand.

“If Greece gets to the point where people won’t take their debts and you cant pay the bills….then the Greeks ultimately have to get their fiscal house in order,” says Richard W. Rahn of the Cato Institute and chairman of the Institute for Global Economic Growth. “If they do that, the crisis goes away quite quickly.”

That may win praise in Brussels, but it will not win votes in Athens and elsewhere in Greece among the public sector unions as well as the country’s rich whose tax burden is light compared to their European brethren.

Fiscal discipline will need a nudge from abroad and Europe’s tradition of decision-making by consensus will have to be applied. 

“It’s going to be politically very difficult but economically it’s the only way to go,” says Werz. “It’s important for the E.U. to set a precedent.”

Experts say any E.U. rescue package should involve the IMF. A cooperative approach—rather than leaving it to the IMF, whose resources are somewhat limited given Greece’s projected $17 billion (14 billion euro) deficit —is likely to limit damage to the euro. 

Greece is entitled to IMF support, and though the organization may not have a lot of money it certainly has ample technical and financial expertise in crafting, executing and monitoring aid packages.

"Getting the IMF involved could be a good way of dealing with the need for constraint," says Lombardi. "Greece agrees to certain policy measures and the IMF tracks the implementation."

IMF involvement also gives European leaders political cover, so the rescue package is not seen as "a takeover of Greece," says Werz. "That would strengthen right-wing nationalist parties all over Europe."

That may be all the more important if other members—Italy, Ireland, Spain and Portugal—wind up needing a bailout.

"It’s the first time the sustainability of the Euro area is put at risk," says Lombardi. "It’s the overall welfare of the Euro area that is a stake."