Analyzing the Relationship between the Federal Funds Rate and Startup Financing Structures during the 2008-2009 Financial Crisis and Great Recession

Abstract

This paper analyzes the relationship between the federal funds rate set by the Federal Reserve and the debt financing structure of startup firms. By looking at this hypothesis through the lens of monetary policy transmission through a “credit channel,” I aim to illustrate that Federal Reserve policy has much broader policy implications towards economic growth beyond its formal mandate of inflation targeting and full employment. This analysis determines if lowering the federal fund rate during the 2008-2009 financial crisis was associated with startup firms prioritizing traditional commercial bank loans over other available financing options, indicating a sensitivity to monetary policy changes. By analyzing the publicly available Kauffman Firm Survey (KFS) data, this analysis applies a firm fixed effects model to determine how this relationship exists over the seven years (2004-2011). The study finds that the federal funds rate correlates with firm financing options and, interestingly, is differentiated by firm revenue expectations. Firms with positive revenue expectations will follow traditional economic theory and borrow more through commercial loans as interest rates decrease. In contrast, firms with negative or zero revenue expectations fall back to using founder personal loans and will borrow more as interest rates increase.