This paper looks at the effects of financial innovation and deregulation on firm debt financing. The aim is to look at the behaviour of firm debt before and after financial innovation has taken place and compare the empirical results with theoretical predictions about the effects of financial innovation. In addition, it also looks at some of the implications of the theories of monetary transmission. The main findings are that the response of firm debt after a monetary shock has changed its sign from negative before financial innovation to positive afterwards, while the response of output has gone from significantly negative to insignificant. These findings seem to be consistent with theoretical predictions about the effect of financial innovation. But they also seem to be different from the broad credit view of the monetary transmission, whereby firm debt should have decreased after a monetary tightening, unless firm demand for financing is stronger than the decrease in the supply of financing. Looking at the behaviour of firms’ inventories reveals that before financial innovation, firms reduced their inventories after monetary tightening, but after financial innovation they increased them. This indicates that they have started to use debt to finance the increase in inventories, which would be consistent with both production smoothing as suggested by financial innovation theories as well as with the broad credit channel of monetary transmission.