French vote to test Europe's stance on austerity

NEW YORK (CNNMoney) -- The election Sunday of socialist Francois Hollande as president of France raises questions about the future of austerity throughout Europe.

France and Germany, the two largest economies in the eurozone, have worked closely together during Europe's nearly three year-old debt crisis.

France's president Nicolas Sarkozy, who conceded defeat to Hollande Sunday, had close ties to German Chancellor Angela Merkel, key proponent of austerity.

Hollande campaigned on the need to focus more on economic growth and less on cutting government spending to reduce public debt. He attacked Sarkozy on his economic record, calling him "president of the rich."

This has made Hollande a symbol of the shift in European politics away from austerity, which has been the main policy prescription for the eurozone debt crisis. It has also raised concerns that Hollande would not work well with Merkel.

In particular, Hollande has said he would renegotiate the "fiscal compact" that eurozone leaders signed late last year. He has said the compact should have a "growth dimension" in addition to measures to enforce fiscal discipline.

While there could be some "initial friction with Merkel," Hollande will eventually form his own bond with the German leader, said Antonio Barroso, an analyst at political research firm Eurasia Group.

"Hollande is very pragmatic." said Barroso. "He knows that Germany is his most important partner. They will have to agree on a solution for the crisis."

What's more, there is not that much difference between many of the candidates' policies. Hollande and Sarkozy have both pledged to balance the nation's budget, although they differ on taxes.

"At the end of day, there's not a huge departure from the status quo," said Barroso.

Still, the election is taking place as the French economy has slowed and the overall euro area appears headed for a recession. Many economists say the emphasis on austerity has only made the situation worse.

"In this context, there is a strong move to reappraise austerity measures with an eye towards more growth," said Jeffrey Bergstrand, a professor of finance at the University of Notre Dame and former Federal Reserve economist. "France under Hollande would play a much more dominant role that Germany would have to respond to."

Hollande is not the only euro area politician calling for more growth-oriented policies. Italy's Mario Monti and Mariano Rajoy, the prime minister of Spain, have both suggested that austerity alone is not the solution to the debt crisis.

Meanwhile, in Greece, voters appeared to be delivering steep losses to the government's governing coalition, raising questions about how the troubled country's austerity program will be implemented. The Greeks have been living with austerity for years and the nation's economy is in a deep recession.

However, the debate between austerity and growth is a "faux divide," said Nicolas Véron, a former adviser to France's labor minister who is now a visiting fellow at Peterson Institute for International Economics.

"Hollande has been saying he wants growth and not austerity," said Véron. "But when you look at policy possibilities, the scope is very limited. There is no room for stimulus in France."

Despite the uncertainty, many investors say the immediate reaction in financial markets will be muted.

A victory by Hollande has been "priced in" to the financial markets for some time, according to foreign exchange analysts at Brown Brothers Harriman. "But the likely market impact will evolve as he reveals more about his policy stances afterwards," the analysts wrote in a note to clients.

One concern for investors is that Hollande may increase public spending, which could call into question France's credit rating. Standard & Poor's stripped France of its top AAA rating last year.