Replication package of my Job Market Paper: Cash Reserves and Short-Term Borrowing under Liquidity Constraints

Governments ensure uninterrupted service delivery with timely payments on operating expenses by maintaining sufficient cash reserves and/or resorting to short-term borrowing. A theoretical model of cash-flow management that shows the precautionary and operational role of cash reserves under liquidity constraints. Using a unique dataset of quarterly financial statements from 2018 and 2022 from Mexican state governments, this paper tests this theory in a setting where local governments face stringent liquidity constraints. To provide causal estimates, I instrument cash reserves with plausibly exogenous variation in the deviation from anticipated monthly distributions of selected federal transfers, which are not correlated with annual financial conditions but lead to temporary changes in states’ potential cash holdings. Consistent with the theoretical model, the main results find a positive effect of cash reserves on short-term borrowing. Furthermore, I found evidence that cash reserves induce lower borrowing costs for short-term debt, implying that additional cash holdings make states more attractive to lenders. Complementing these findings, I document that the increase in short-term borrowing is larger for states with lower credit quality. These findings are consistent with theoretical expectations of cash management under liquidity constraints and provide ev- idence that complements the previous empirical research studying American local governments with softer credit constraints.