I was recently on a Bloomberg radio programme during which the host, Sara Eisen, provided updates every ten minutes or so on the probability that the market was giving to a Greek default. It rose steadily closer to 100 per cent through the hour.

The question now is not if Greece will default - it simply cannot afford to pay back its debts of roughly €350bn (£305bn) - but how much the necessary bailout will cost (a "haircut", or write-off, of 50 per cent of the debts seems inevitable) and what harm will have been inflicted on the world economy by the pathetic dithering of European policymakers.

I recall the president of the European Central Bank (ECB), Jean-Claude Trichet, saying, when Greece first stood on the verge of default, on 6 May last year, that the governing council had not even discussed a bailout. The best that can be hoped is that he was lying. All other explanations - in short, incompetence - are worse. The bailout was announced four days later, on 10 May.

At the time of writing, it is still all dither and no action. There is, at last, a growing prospect that the members of the ECB's governing council will vote to lower interest rates at their final meeting before Trichet steps down as president at the end of October and the Italian Mario Draghi takes over. It's an embarrassing policy reversal; they should never have been raised in the first place. Despite slowing growth, falling inflation and rising unemployment across the eurozone, the ECB has raised rates twice this year, just as it did at a critical moment in the financial crisis in October 2008.

Catastrophic risk

The rescue plan that is now being discussed - no longer just for Greece, but for the whole eurozone - apparently includes a large increase in the amount of lending to nations and their banks through the European Financial Stability Facility (EFSF).

This is what the US treasury secretary, Timothy Geithner, suggested was needed when he warned at a meeting of the International Monetary Fund in Washington on 24 September that failure to combat the Greek-led turmoil threatened "cascading default, bank runs and catastrophic risk".
The idea is that the current limit of €440bn (£380bn) could be leveraged up to €2trn (£1.7trn) through the ECB, so that there is enough money in the coffers to backstop Italy and Spain. It's a good start, but even that might not be enough if the crisis spreads to France. Eventually the fund might have to expand to as much as €5trn. I remember voting in favour of £75bn of quantitative easing (QE) in March 2009, and I thought that was big money.

Where does all this leave the UK economy? The Bank of England's Monetary Policy Committee (MPC) is likely to agree on more quantitative easing soon, perhaps at its October meeting, but most likely in November, when it produces its next quarterly forecast. That much was clear from the minutes of its last meeting, as well as from comments made by the new external member Ben Broadbent, who said he came close to voting in favour of more QE in September.

There is gathering momentum behind the push by another MPC member, Adam Posen, and myself to expand the Bank of England's asset purchases to help small firms. The Chancellor, George Osborne, has suggested that he would support such a plan to get money to cash-constrained small and medium-sized businesses, but QE on its own is unlikely to be enough. Monetary policy and fiscal policy have to work in the same direction to be effective, and at the moment that's not happening.

During his speech to the Labour party conference in Liverpool, the shadow chancellor, Ed Balls, announced a five-point plan for change. Step one: repeat the bank bonus tax this year and use the money to build 25,000 affordable homes and guarantee a job for 100,000 young people.

Step two: bring forward long-term investment projects (schools, roads and transport) to get people back to work and strengthen our economy for the future.

Step three: reverse the damaging VAT rise for a limited period.

Step four: an immediate one-year cut in VAT to 5 per cent on home improvements, repairs and maintenance to help homeowners and the many small businesses that are dependent on the housing market.

Step five: offer a one-year National Insurance tax break to every small firm that takes on extra workers.

All of these policies are sensible, but they are pretty timid - Osborne-lite. It was disappointing that Balls went no further than saying he would "examine proposals for a National Investment Bank for small business". I hope he does that quickly and adds his support, because such a measure is likely to boost job creation and hence growth. Labour desperately needs to offer both a credible long-term deficit-reduction plan and a viable short-term plan for growth that are distinctly different from what the government is offering.

Give us incentives

Osborne is known as a weasel politician because he will do whatever it takes to gain a political advantage. Given that the possibility of introducing income-tax cuts before the next election in 2015 is decreasing fast, some sort of government U-turn on economic policy is becoming increasingly likely.

What happens if the British economy tanks as a result of Europe's spreading financial crisis? Osborne could plausibly argue that, through no fault of his own, his growth forecasts are not materialising. He could then adopt one or more of Balls's proposals and, along with cuts to corporation tax and further reductions in National Insurance, he could claim the moral high ground.

Balls has to get ahead of the game. He should argue that now is the time to give firms big tax incentives to create jobs that get the economy moving again, with the extent of the tax cuts to be determined by the scale of any negative shock to Britain's economy from the eurozone crisis. This would get employers on his side, and could easily be targeted to help the young, which would also be popular.

David Blanchflower is the New Statesman's economics editor and a professor at Dartmouth College, New Hampshire, and the University of Stirling