Cuba’s fixed exchange rate

Cuba’s currency is very unique because Cuba is a country, which has 2 currencies.  Cuba has Cuban peso and Cuban convertible peso (CUC). However, the CUC is pegged to the dollar and worth 25 times as much as the CUP. Although most Cubans are paid in CUP, nearly all consumer goods are priced in CUC. The system, which highlights divisions between those with access to hard currency and those without, has proved unpopular. The Cuban convertible peso (CUC) has its value pegged at 1:1 to the US dollar. In 1994, the Cuban Convertible Peso was introduced alongside the existing Cuban Peso. Until 2004, Cuba used the Peso (CUP) for non-luxury items and staples; the Convertible Peso and the US Dollar were used mainly in the tourism trade and for luxury items. In 2004, the US dollar was no longer accepted in Cuba and the convertible peso was the only option left for businesses to conduct trade in and a 10% tax was charged for converting USDs to convertible pesos. This tax does not apply to any other currency. In 2011, Cuba pegged the Convertible Peso to the USD at par. From 2011, it stayed unchanged at 1CUC= 1USD.

 

* The demand comes from USA and the supply comes from Cuba.

 

Although Cuba’s currency is already quite stable, Cuba’s central bank or government will use policies to control demand and supply of the currency to maintain the fixed currency.

Initially, there is equilibrium in the peso market, at point A. Suppose the U.S. occurs a leftward shift in the demand for pesos because of a fall in demand for Cuba’s export for example, then the demand for pesos’ curve shifts from D1 to D2. At the fixed exchange rate of 1 CUC = 1 USD, there is an excess supply of Peso (the distance A − B). Under a floating exchange rate, the exchange rate would fall to point C, eliminating the excess supply; but if the fixed exchange rate of 1 dollar per peso is to be maintained, the central bank or government must intervene. If the central bank wants to maintain the fixed exchange rates, it can increase the interest rates because increase in interest rates attract financial investments from other countries. This leads to a higher demand for the domestic currency, shifting the demand for Peso back to D1. Otherwise, government can borrow from abroad, its loans will come in the form of foreign exchange, which when converted into Pesos will cause an increase in the demand for Pesos and hence a rightward shift the demand curve toward D1.

The government can also use policies to limit imports as it can reduce the supply of the domestic currency and causes a leftward shift in the currency supply curve from S1 to S2, with the exchange rate remaining fixed at $1.00 = 1 Peso, which is point B. To limit imports, governments can use contractionary fiscal and monetary policies, which lower aggregate demand, lower incomes, and therefore result in fewer imports, or trade protection trade policies, which work to directly lower the quantity of imports that can enter the country. However, contractionary policies may lead to recession, while trade protection comes with numerous disadvantages, including the possibility of retaliation by trading partners, which would result in lower exports. Furthermore, Cuba’s government can pose exchange controls on the quantity of foreign exchange that can be bought by domestic residents of a country, which limits the outflows of funds from the country, but it may cause serious resource misallocation.

Besides, Cuba’s main sources of foreign currency today are exports of its medical services,which means that if Cuba want their exports to be competitive with the market in the world,  it will also peg their currency to the dollar.  If Cuba export a lot to the United States,  pegging their currencies to the dollar can maintain their competitive pricing. They can keep the value of their currency lower than the dollar. This gives them a comparative advantage by making their exports to America cheaper.  Additionally, as Cuban government believe to be impossible for Cuban customers to pay and attempts to explore oil reserves in the sea haven’t had any encouraging results and most of the oil-exporting nations in the Gulf Cooperation Council peg their currency to the dollar because oil is sold in dollars like Abu Dhabi’s investment in 2008, Cuba need to buy oil in dollar.  Then, it’s easier for them to buy it if they peg to the USD.

 

 

 

 

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