Is Austerity the only answer?
"The worst is over," proclaimed Mario Draghi last month in an interview with a German tabloid newspaper.
The European Central Bank president was drawing comfort from the fact that two blasts from his big liquidity bazooka, known as the Long-Term Refinancing Operation, had successfully lowered Italian and Spanish interest rates and assuaged fears of an impending Continental banking collapse.
The successful Greek sovereign debt write-down - avoiding a catastrophic default - had also bolstered the confidence of the single currency's policymakers in Frankfurt. But what became clear last week is that, just as with Mark Twain, reports of the death of the eurozone sovereign debt crisis have been much exaggerated.
Investor nerves over sovereign debt have returned. Spain is a particular concern for markets. An auction of medium-term paper by the Spanish treasury last week only just scraped over the AUD$2.5 billion target. And the interest rate on the eight-year bonds placed was higher than the last time Madrid sold debt of a similar maturity.
Spanish 10-year bond yields are now higher than they were when the first shot of the ECB's bazooka was fired on 22 December. Italian 10-year yields rose through March too, although they remain considerably down on the 7 per cent distress levels of last autumn.
So what does Mr Draghi say now?
The ECB president was asked about these signs of financial stress at his monthly press conference last Wednesday. Mr Draghi argued that what is driving the financial markets is a concern that the Spanish and Italian governments will not be able to deliver on their promised labour market reforms and austerity programmes.
The appropriate response, he said, was for those administrations to plough on with fiscal consolidation.Yet this explanation does not make sense.
Spain has already implemented a comprehensive (and necessary) overhaul of its inefficient labour market regulations. And just nine days ago, it announced its most austere budget since the death of General Franco, a fiscal consolidation over one year of 3.2 per cent of GDP. Both were very clear signals of intent.
If the markets were concerned about Madrid's commitment to fiscal discipline, as Mr Draghi claims, they would have shown signs of reassurance, not alarm.
What actually spooked markets is the growing recognition that, even with the swingeing new austerity measures, Spain is likely to require an official bailout at some point.
A combination of collapsing growth and an unreconstructed banking sector could blow up the country's public finances and force Madrid to seek support from its eurozone partners and the International Monetary Fund. And that is something that could ultimately put investors in Spanish public debt in danger of losing their money, just as Greek bondholders have had to accept severe haircuts in recent months.
And it is not just Spain that is at risk. Growth across the single currency is set to take a hammering as nations embark on simultaneous fiscal consolidations.
The European Commission's forecast is for a eurozone contraction of 0.3 per cent in 2012. That aggregate masks some big individual declines.
The Spanish economy is expected to shrink by 1.7 per cent this year.
Italy is looking at a 1.3 per cent contraction.
The outlook for existing bailout recipients is still worse.
Greece is expected to contract by 4.4 per cent and Portugal by 3.3 per cent.
Many investors expect Athens and Lisbon to tap the EU and the IMF for still more money in due course. That could stretch the communal rescue resources of the eurozone very thin. Last month's agreement by finance ministers to boost the size of the bailout funds to A700bn involved a good deal of double counting.
The real capacity is just AUD$500 billion. That would cover just a quarter of Italy's national debt.
The theory that deep spending cuts and tax rises at a time of economic weakness can prove self-defeating is hardly novel. John Maynard Keynes first identified the "paradox of thrift" in the 1930s. And the point has been repeatedly stressed by Keynesian economists over the past four years since the global financial crisis.
Even the fiscally disciplinarian IMF urged governments last year to support near term demand, while pushing through budget consolidation over the longer term.
European leaders claim they are alive to the need to encourage growth as well as to cut deficits. The Finnish Prime Minister, Jyrki Katainen, came up with the term "growsterity" last month to describe the appropriate policy path for the eurozone.
But this is mere rhetoric. There remains far more austerity than growth in the European policy pie. Indeed, European policymakers seem to believe that austerity itself is the best stimulus since it will, they argue, boost confidence and encourage investment.
Their certainty on this point is striking. Earlier this month I spoke to Mr Katainen, who was on a brief visit to London, and asked him what should happen if that flood of investment he expects to begin later this year does not materialise.
Would it be time to think again and perhaps ease up on the cuts?
His response was telling. Mr Katainen said that he simply could not imagine the circumstances in which slowing down the pace of fiscal consolidation would help distressed economies.
So there you have it. Anything except punishing austerity at a time of recession is literally unthinkable for Europe's policymakers.
Faced with such intransigence, is it any wonder markets are worried?