Jonny,
In Larry Pina's book Mac Classic & SE Repair and Upgrade Secrets (ISBN 1-56609-022-9), the plain gray Desktop and the error code are mentioned as possible symptoms of a faulty filter network on a Macintosh SE or SE/30 logic board. I do not know whether the same could be true for a Macintosh Classic.
It could perhaps be worth checking whether the logic board battery is OK. Sometimes a bad battery can cause strange effects.
Normally, an older Mac with a built-in floppy drive is used (together with Disk Copy 4.2 or 6.3.3) to create properly sector-copied floppies from (for example, System 7.0.1) disk images downloaded from Apple.
http://download.info.apple.com/Apple_Support_Area/Apple_Software_Updates/English -North_American/Macintosh/Utilities/Disk_Copy/
http://download.info.apple.com/Apple_Support_Area/Apple_Software_Updates/English -British/Macintosh/System/System_7.0.1/
The article below indicates that it may be possible to use a Mac OS X computer (I have not tested that). It may be something similar with Linux.
http://lowendmac.com/brierley/08pb/classic-mac-boot-floppy.html
If absolutely necessary, one can even create some floppies on a Windows PC (via a special procedure, with an appropriate utility for disk images).
Jan