After moderate price increases in the last two decades the 2300% devaluation of the peso in January 2021 and lax macro policies brought high inflation to Cuba which is cutting real salaries and wages. Hyperinflation followed the tarea ordenamiento or monetary reform aimed at erasing the overvaluation of the peso while unifying the CUP and CUC, the two national currencies. In this note I survey recent inflationary developments, fiscal and monetary policies and the return of macro policies similar to those behind the financial crisis.
A Tale of Two Inflations
There are two main consumer price indices in Cuba. The most visible is the consumer price index published monthly by the ONEI statistical institute (ONEI 2022A). This refers to a basket of essential goods and services driven by foodstuffs. Most items in the CPI basket are sold at controlled prices in state stores. Many of these items are acquired by means of the libreta or ration book. A broader index is the deflator of household consumption expenditure derived from the national income accounts also published by ONEI (ONEI 2022B). It measures the price of all consumption expenditure by households in the country and is weighted by outlays in each consumption item in the national accounts.
Table 1 shows values for the two price indices in 2011-2022. The deflator and the CPI averaged annual changes of 2.7% and 3.4% respectively in 2011-2020. Year-to-year differences between the two indicators arose from the different composition and weighting of the indices as well as from administrative price changes in the CPI basket. However, the two indices up to 2020 displayed a consistent trend. This changed after the monetary and exchange rate shock of January 2021. Consumer inflation in 2021 measured by the CPI was 77% while the consumption deflator posted a 439% increase. Why is there a six-fold difference between the two indices in 2021?
The straight answer is the impact of the 2300% devaluation of the official exchange rate of the peso in 2021 reflected in the consumption deflator and not on the CPI with its administered prices (Luis 2021). An important question is whether or not consumers are able to satisfy their basic needs at prices in the CPI. In the affirmative the CPI represents the effective consumer price inflation. Otherwise the CPI undercounts the inflation experienced by the average family. The undercount is a multiple of measured CPI inflation as families get necessary goods outside of state stores.
There is a fiscal dimension to the divergence between the two price indices. Prices of many goods and services in the CPI particularly foodstuffs are subsidized by the government and are posted at levels that do not reflect domestic or international costs. The tarea ordenamiento was said to eliminate or greatly lower subsidies. This is not taking place. Data on state expenditure on social services in 2021 indicate outlays rose by 238% well in excess of the CPI but below the consumption deflator (ONEI 2022C). This provides food for thought on the range of needed subsidies to compensate consumers for the loss of purchasing power. It is no accident that 480 state companies report losses in 2022 mostly attributed to price ceilings in the state sector (Gil Fernandez 2022).
Inflation is slowing in 2022. The CPI rose 29% in the first 10 months and 40% on a 12-month basis. The consumption deflator will show 2022 inflation at a higher level than the CPI as it will register imported goods prices close to international levels. The rise of the dollar in the parallel market also signals that families are suffering higher inflation than measured by the CPI.
Fiscal and Monetary Dynamics
High inflation in Cuba came about from weak macro policies: an unhinged fiscal and monetary stance combined with a fixed exchange rate. Moreover flawed macro policies were carried out in an inflexible economy. Rigid central planning and controls undermine resource allocation, productivity and pose a barrier to the capitalization of private activity. The mix of inadequate policies and controls resulted in distortions and repressed inflation. The tarea ordenamiento was meant to ease distortions while inevitably launching a monetary and inflationary shock in 2021. Supply constrains exacerbate inflation.
Expansive government policies in 2017-2018 were followed by some restrain in 2019 even with a rise in public sector wages (Table 2). Caution was thrown to the side in 2020 as an attempt to offset the hit from the pandemic on export revenues led to a sharp rise in expenditures and a 38% boost to public sector wages. In fact labor income from the public sector in 2020 was 22% greater than state sector sales to the population compared to minus 19% in the previous two years (ONEI 2022D). In other words wages from the public sector in 2020 exceeded the supply of goods available. The budget deficit reached 18% of GDP in 2020. Government outlays in 2020 were backed up by financing from the central bank and a hefty 51% expansion of the money supply (M2A). Stimulus to aggregate demand beyond the capacity of the economy is behind 18% CPI inflation in 2020 prior to the launch of the tarea ordenamiento.
There was a four-fold expansion in government outlays in 2021. These were largely driven by the peso mega-devaluation which hit the price of imported goods and required a boost in subsidies while labor costs tripled in the public sector. The budget deficit reached 12% of GDP. Hyperinflation in 2021-2022 came about from the 2300% devaluation of the peso alongside demand pressures arising from hefty public sector expenditures.
Evolution of Exchange Rates
Cuba has an intricate exchange rate regime. It is a multiple exchange rate system with three rates operating in various forms for most of the current century. Two of these are official exchange rates, and the third is a parallel market rate. In the period up to the end of 2020 the two official rates matched the two currencies in the island the CUP and the CUC. In 2021 and 2022 there was an official rate of CUP 24 = US$1 for the central government and state enterprises, but it was not generally available for dollar sales to the public. A new retail rate opened in August 2022 and is available to the public on a limited scale at exchange houses (CADECA). The third rate is set in the informal or parallel market. The parallel market operates throughout the island and widely in the internet. It is a decentralized market with transactions taking place at rates that vary around a central value. Here I use the median of transactions observed in the internet and reported by eltoque.com (El Toque 2023). The CADECA window that opened in August 2022 affected the parallel market by the diversion of dollar supply (Vidal 2022A).
Table 3 shows exchange rates in 2017-2022. As mentioned above the main event in this period was the maxi-devaluation of the peso or CUP on January 1st, 2021. The CUC’s rate did not change at that moment as it was set at CUP 24 = CUC 1 = US$1 and was gradually withdrawn from circulation. However the CUP depreciated in the parallel market ending 2021 at CUP 72 = US$ 1 or a 125% rise in the value of the dollar. The closure of dollar sales in exchange houses (CADECA) and continuing expenditures by the public sector in excess of revenues fostered a convulsive parallel market in 2022 with the dollar rising at one point to near CUP 200. The government in August 2022 reopened CADECA sales offering limited amounts of dollars at CUP 125 = US$1. Reportedly there was some fiscal tightening in the second half of 2022 that lowered dollar demand. The parallel market closed 2022 at CUP 170 = US$1 an annual devaluation of 136% (El Toque 2023).
Movements of the dollar in the parallel market affect the price of goods and services outside of the controlled public sector. The peso depreciation in 2022 has such an effect even as it recovered some value in the last quarter of 2022. To be sure the public sector uses the fixed rate of CUP 24 = US$1 masking dollar movements in the free market. The higher dollar rate at CADECA also impacts price setting in the private sector and bears on expectations of price increases by public companies and the government.
Return of Failed Policies
Cuba’s macro policies in early 2023 resemble the failed policies in place in the last decade prior to the tarea ordenamiento. A fixed and overvalued exchange rate anchors the controlled prices. This involves hefty subsidies financed by monetary expansion and a system of dollar stores with high markups. The gap between the official and parallel exchange rates at the end of 2022 was 600%. While the government attempts to cool demand by easing growth in public sector outlays, rising import costs further erode the wellbeing of families. The CPI index of largely controlled prices masks the actual inflation hitting the population. Importantly structural changes are needed alongside effective monetary and fiscal policies (Vidal 2022B).
On a longer-term horizon the failure to liberalize the economy, introducing institutional changes and allowing the functioning of markets restrains the growth of production. Recent changes in the legal status of small enterprises is only a small step. It masks the flaws of a system that restrains capital accumulation, productivity and growth.
Cuban families suffer from high inflation following the maxi-devaluation of the peso on January 2021. There are two main inflation indices telling different stories. The official consumer price index (CPI) largely measures administered prices while the deflator from the national accounts covers all household consumption. It showed 2021 consumption inflation at 439% to be 5 2/3 times more than reported by the CPI. Lax macro policies in 2019-2020 fueled inflation ahead of the devaluation and seeded peso overvaluation. Current macro policies resemble those in place before the tarea ordenamiento or monetary reform with an overvalued exchange rate and the public sector fueling demand against rigid supply a mix that sustains inflationary pressures. The government is failing in reforming the economy and lifting restrictions on the functioning of markets and the capitalization of the private sector.
El Toque, 2023, “Mercado informal de divisas en Cuba (tiempo real).” Eltoque.com, 1/1/2023.
Gil Fernandez, A., 2022, “No se alcanzan los niveles proyectados en la economía.” cubadebate.cu/noticias/2022/12/12
Luis, L, 2021, “Inflation in Cuba 2010-2021.” asecuba.org. May 19, 2021.
ONEI, 2022A, “Indice de precios al consumidor base 2010, edición noviembre”. Onei.gob.cu
ONEI, 2022B, Anuario Estadístico de Cuba 2021. Cuentas nacionales. onei.gob.cu, 2022.
ONEI, 2022C, Anuario Estadístico de Cuba 2021. Finanzas. onei.gob.cu, 2022.
ONEI, 2022D, Anuario Estadístico de Cuba 2021. Empleo y salarios. onei.gob.cu, 2022.
Vidal, P, 2022A, “¿150 pesos por dólar, por qué volvimos a este punto?” eltoque.com. 5/septiembre/2022.
Vidal, P.,2022B, “Diez puntos para un programa de estabilización de la economía cubana.” horizontecubano. law. Columbia.edu. octubre 24, 2022.