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These measures can slow down future economic growth that may force firms to reduce cash holdings because there are likely less investment opportunities under such circumstances (Kim et al. 1998). In fact, before reaching the goal of stimulating the economy, the recent surge in government spending has caused severe problems in countries where governments were highly indebted before the crisis. For example, the debt crises in Greece and Ireland in 2010 raised an alert for other European countries and the rest of the world with similar situations. Hence, from the perspective of future economy and investment opportunities, the impact of government deficits on corporate liquidity depends on the relative strength of the short-run (positive) and long-run (negative) effects of government deficits. Therefore, firms should increase cash holdings if the short-run effect is more overwhelming than the long-run effect, and vice versa.
However, from the perspective of economic uncertainty, firms are likely to increase cash holdings as a precautionary measure when government deficit is higher and the future economy is filled with uncertainty. There are also other potential channels through which government deficits affect corporate liquidity, and these deserve to be carefully examined. In the presence of high government deficits, optimal liquidity management is an open question, which calls for thoughtful analysis on how government deficits signal other macroeconomic conditions in the future to balance things out.
In all, larger economic concepts should have an overriding impact on the financial decisions of firms than firm-level characteristics; hence, macroeconomic conditions should have a bearing on corporate liquidity and deserve the attention of firms. In particular, increasing government deficit should be formally considered in liquidity management. This is because government deficit actually involves uncertainty despite its intended goal of stabilizing the economy and promoting economic growth. However, minimal research currently provides theoretical foundation to explore the relationship between macroeconomic conditions and corporate liquidity. This issue should not be ignored because national governments have been running budget deficits to ride out the recent global crisis and boost their respective economies. Corporate liquidity, one of the major financial decisions of firms, should be adjusted optimally to better cope with the potential impact of government deficits for sustainability.
This study aims to fill this gap using data from Taiwan to analyze the macroeconomic perspective on corporate liquidity, with emphasis on its relationship with government deficit. Single-country data are used because they provide a cleaner comparison and interpretation of results than multi-country data, which introduce cross-country differences that are difficult to control for and likely to complicate the analysis. In addition, Taiwan is a developing country where the documented relationships between government deficits and other macroeconomic conditions are more certain compared with other developed countries (Saleh and Harvie 2005). Furthermore, the Taiwan government has been experiencing a constantly increasing government deficit since a decade ago, especially after the 2008 global crisis. Given that government deficit signals future economic uncertainty and causes a major concern for Taiwan’s people, conducting an examination of how government deficit is historically linked to corporate liquidity is worthwhile. This is because liquidity is an important corporate decision, and useful implications regarding how to maintain liquidity optimally can be provided for firms operating in today’s environment characterised by high government deficit. fully