Cuba’s Central Bank Doesn’t Understand Demand for Cash
By Pavel Vidal Alejandro (El Toque)
HAVANA TIMES – Cuba’s Central Bank’s Resolution 111 issued in 2023, and explanations given by its new president on the Mesa Redondoa TV show, prove the lack of understanding they have about a key concept in any country’s monetary policy: demand for cash money. This simple formulation helps to show the factors that influence peoples’ money holdings and illustrates the essential relationships that need to be taken into account when making monetary policy decisions.
The amount of currency an economy needs depends on four key variables:
1. Transaction Value: This is linked to money’s function as a payment method. Money is used to buy and sell available goods and services for a certain price. Demand for money grows if there are more transactions (this can be calculated by real GDP growth) or if prices of goods and services increase as a result of inflation.
2. Interest rates: This is the price of the opportunity to keep money in its cash form. If interest rates increase, it’s an incentive for people to deposit their savings in a bank and discourages people from keeping cash.
3. Transaction costs, technological advances and payment systems: The evolution of financial technology (Fintech) and payment systems influence demand for money, because they reduce financial transaction costs and make it easier to convert savings into cash. For example, swipe cards, electronic payments and other digital means tend to reduce the need for physical cash.
4. Velocity of money circulation: This is the velocity at which money changes hands over a certain period of time. This variable includes many factors that influence people’s and companies’ preference for holding onto more liquid funds. It goes hand-in-hand with their expectations of the future of the economy, the informal market, uncertainty, etc. This is the most difficult variable to predict and changes erratically a lot of the time, making demand for money unstable.
By putting these four factors into Cuba’s current context, we are able to understand why demand for money has changed so drastically. Cash in circulation grew 10% every year between 2000 and 2017; but it grew at an annual rate of 86% between 2020-2022.
Rampant inflation and the devaluation of informal exchange rates increased the need for larger sums of money to pay for goods and services, and to buy foreign currency. While real GDP and the number of transactions have decreased, prices have multiplied on many occasions and more money is needed.
Nominal interest rates remain fixed, making them extremely negative in concrete terms. In other words, people are losing money by keeping it in the bank, as their purchasing power dwindles every day because of inflation. Banks haven’t made up for these losses with saving accounts by adjusting their rates to the current monetary situation in Cuba.
Transaction costs to withdraw cash at banks or at an ATM also encourage demand for money. Huge lines, out-of-date technology and intermittent telecommunication services are just another reason to keep cash outside of the bank.
The speed with which money circulates also explains increased demand for cash. Calculated using the nominal GDP, the velocity of cash circulation dropped 38% over the past five years, compared to the average recorded betwween 2000-2017. This downward spiral of cash velocity has been crystal clear since 2012.
It reflects a structural change in the economic system with the evolution of the private sector, but it can also be an indicator of greater informal activities and uncertainty. This change is being translated into a greater demand for cash so the Cuban peso can serve as a payment method and store of value.
A recessionary solution
In the explanations mentioned on Mesa Redonda, a concept as basic as demand for money isn’t highlighted. The financial logic behind Resolution 111 is based on an obsolete model of cash revenue and expenditure between state-controlled banks and households. The graph (without numbers) and analysis given on Mesa Redonda to show that money was leaving the banks and not coming back, is a very ‘80s take on assessing monetary policy. It isn’t in line with the structural changes that have been taking place within the Cuban economy.
With the diversification of labor, trade, markets, production and the private sector’s greater participation, the banks’ model of cash revenue and expenditure isn’t saying anything useful if it doesn’t also evaluate the deciding factors of demand for money. Cash doesn’t have to leave and come back to the banks. There is a changing and autonomous demand for money in households and the private sector that can’t be ignored.
If the Central Bank wants to have an influence on reducing demand for money, it will have to put a stop to rampant inflation, first and foremost. To do this, it needs to stop monetizing the huge fiscal deficit, which means implementing the macroeconomic stability program they announced. Another key factor of demand for money that they can change is interest rates. By increasing interest rates (at least in proportion to the inflation rate), they would be increasing the cost of holding onto cash.
But no. Administrative measures continue to be the plat du jour, no matter how much they write and say the opposite in I don’t know how many documents.
The Cuban Government has decided to apply a forced banking service and a swift digital payment system that needs to be implemented in just six months. They are expecting this to happen in a country with the most backward telecommunication infrastructures in the world and with one of the most underdeveloped banking and payment systems in the region, and with an aging society.
They not only seem to be ignoring the fact that advances in bank services and digital payment take years or decades, but that trust is also a key factor in these hopes. Not too long ago (2021), families saw how 80% of the value of their bank accounts vanished as a result of “Currency Reform”.
Today, almost no central bank is chasing specific objectives linked to the amount of cash in circulation. This was a widespread practice in previous decades, but it failed because of unstable demand for money and how difficult it is to predict what the “optimum” amount of cash is needed in an economy.
Central banks moved towards strategies that focused on inflation rates, interest rates and diversifying monetary transmission mechanisms. Demand for money has always been an endogenous variable in the economic and financial climate. Central banks provide the economy with all of the money it demands. If they don’t, they know that the consequences will be recessionary.
Money is like the oil that keeps the engine of the economy moving. If you don’t give it the oil it needs, it burns out. The worse thing is that we don’t have a magic wand to know just how much money the economy needs, it constantly changes and for a variety of reasons.
This hasty freeze on cash and a digital payment system proposed by Cuba’s Central Bank is extremely recessive, in its attempt to know how much money is needed in the economy or needs to return to the banks, ignoring the deciding factors of demand for money and the context that the private sector and households are engaging in.
It shows their greatest shortcomings in understanding how monetary policy works, as their explanations why a forced reduction of cash in circulation will help to stop inflation and keep the informal economy in check.
Ever since the 1990s, the Cuban Government hasn’t been able to provide a national convertible currency with an exchange rate in keeping with the country’s economic and financial reality. The economy has had to malfunction with partial dollarization, currency duality, multiple exchange rates, the overvaluation of the official exchange rate and exchange controls.
This cocktail of currency distortions now joins the inability, and now their rejection, to provide the cash the economy needs.
Let me sum up this whole article with one sentence: “Cuban banks do not understand even basic economics, such as, that people need cash to buy things in Cuba.”
Well, there’s a surprise!
Any foreign tourist who has ever been to Cuba knows that they have never understood that, not even before inflation became such a big problem. Remember trying to exchange money at the Banco Metropolitiano in Varadero? Standing in a huge long line inside the bank for an hour, while only 3 or 4 of the 7 teller cages were staffed; while outside, more tourists stood there, waiting to be allowed entry into the bank. They could never seem to understand that tourists are only there for a week, and if they want them to spend money, why make them waste their vacation time trying to exchange their foreign currency to get Cuban cash to spend? And year after year, without fail, the very same idiocy continued. If they couldn’t correct even such obvious inefficiencies, what makes anyone think they would have the economic acumen to adapt wisely to any changing circumstances?
Elma Kutra:
“Soon Russians and Chinese tourists will fill the gap left by countries who do not support Russia. Fact not fiction!” This sentence is not factual.
Canada does not support Russia. In fact Canada hardly supports China. That said, I doubt it very much whether Canadian tourists will boycott Cuba en masse. Personally, I don’t think so. Many Canadian tourists have made lifelong friends with ordinary Cubans. Canadian tourists will continue to support their Cuban friends.
I speak specifically of those Canadian tourists who visit and/or vacation there on a regular basis. Some are very aware of the present economic problems persisting with their Cuban compatriots. These aware and astute tourists bring with them in their suitcases much needed medicines, toiletries, children’s clothing, shoes, school supplies, all goods not readily available to the majority of ordinary Cubans. Canadians are a generous people willing to help where desperate aid is needed.
Some tourists, whether Canadian or otherwise, choose to lodge in “casas particular “ thus financially supporting a Cuban entrepreneur. The tourists on each visit look forward to reacquainting themselves with lodge friends. This financial support provided to the landlord is, so to speak, manna from heaven.
Will Russian and Chinese tourists flock to Cuba as tourists ? I don’t know. Before the Russian invasion of Ukraine when the Russian rouble carried some economic value, the Cuban tourism sector certainly was never overwhelmed with Russians. Canadian tourists to Cuba have always ranked number one. It has been my observation ordinary Cubans are not that enamoured with Russians. Now with the Russian invasion ordinary Cubans are enamoured even less so. With the Russian rouble having lost much of its past monetary value, a Cuban vacation for the ordinary Russian will be very, very expensive.
Absolutely the totalitarian henchmen in the offices of power are enamoured with everything Russian and genuflect to their brethren Russian oligarchs when they visit Cuba because of ideological reasons and because of economic dependence.
So, in the final analysis Cuba still relies heavily on Canadian tourists and I don’t see that changing any time soon.
Very clear article!
Too bad the government understand the true art of service for and by the people.
Cuba seems to be an inverted pyramid!
The people at the top fail to serve and protect the population. Instead it as though the total population has to support the people at the top and, incredibly none of them voted in by the public; simple appointed with the promise and opportunity to get ‘fat’ on public perks as in free cars, subsidized housing gas and exclusive favors like preferential licensing etc.
Watch any broadcasts and see the amount of so-called elected officials falling asleep, on their telephones and clearly over-weight meaning the vast majority of their energy goes to the stomach; it seems all the leaders shirts are too small to accommodate their out of pro-portion stomachs. What a metaphor for the real political status quote eh?
A million such intelligent articles like this one by Pavel Vidal Alejandro (El Toque), while insightful and intelligent, will fall upon deaf ears because the assumption is that the government really cares. They are only interested in themselves and padding their power after all what do the need in the form of food, money, cars, houses etc?! Nothing!
Lastly, so many of the status quo government officials display little initiative to implement change for fear of ‘crossing the hardline’ and losing thier position. You can petition God with prayer but never the Cuban government.
From afar, from another country I salute the poor, sick, honest and pure working class Cubans who deserve salvation and a more hopeful Cuba but like so many other tourists, we will not be returning to the pathetic state and feel betrayed by the false advertisising of the hotels, lack of food and mafia style tactics daily controlling the streets. Desperation has caused good honest people to entertain petty crimes to support themselves with little regard for tourists. Soon Russians and Chinese tourists will fill the gap left by countries who do not support Russia. Fact not fiction!
Good luck with the economy – an economic tsunami is heading to Cuba and the Cubans are heading to the beaches in bikini thongs!
Just my opinion but I am not the only one.