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The global financial crisis has shown that money affects the real economy. This study examines the influence of the price and stock of money in the economy on capital structure throughout the business cycle during the last financial crisis, with particular focus on the roles of long- and short-term interest rates, spread rates, and liquidity as reflected in the supply and velocity of money. The results, for a panel of listed European firms, indicate the significant impact of these variables on leverage, which they find to be linked positively to long- and short-term interest rates and negatively to term spread in both phases (expansion and recession) of the business cycle. They also suggest that liquidity requirements play a crucial role in the corporate financing decision. Finally, the speed of adjustment to the target debt ratio, normally significantly lower during recessions than during expansions, appears subject to business cycle fluctuations.

Interest rates, liquidity and the corporate financing decision throughout the business cycle: a European analysis