The US has reopened its embassy in Cuba more than 54 years after it was closed, in a symbolic step signalling the warming of ties between both countries.
John Kerry, the first US Secretary of State to visit Cuba in 70 years, presided over the ceremony in Havana.
The US flag was presented by the same US marines who brought it down in 1961.
Mr Kerry said the US administration wanted to lift the trade embargo on the island - something that the Republican-controlled US Congress has blocked.
In an open letter on Thursday, former Cuban leader Fidel Castro said the US owed Cuba millions of dollars because of its 53-year-long embargo.
Mr Kerry described the hoisting of the flag as a "historic moment" speaking during the ceremony on Friday.
But he also warned that the US would not stop pressing for political change in Cuba.
"The people of Cuba would be best served by a genuine democracy, where people are free to choose their leaders," he told a crowd of hundreds gathered outside the embassy building.
Mr Kerry said Congress will not lift the economic embargo if there is no movement on issues of freedom of conscience.
At the scene - Jon Sopel, BBC North America editor
Diplomacy is the cold and rational pursuit of national interest. But twice I saw John Kerry wipe his eye at the end of his speech at the American embassy.
The handing over of the flag by three old men who 54 years ago as young marines took it down; the US army band striking up the national anthem; the Stars and Stripes hoisted once more - this could never be seen as just cold diplomacy at work. There was emotion.
On both sides. US-Cuban relations are entering a new era, and though there will be difficulties ahead and fresh misunderstandings, for those who had brought this restoration of diplomatic relations about, today was one to savour in the Caribbean heat.
In the past, he conceded, US policies have not led to democracy. "Cuba's future is for Cubans to shape," he added.
Mr Kerry and his Cuban counterpart, Bruno Rodriguez, later announced the setting up of a joint commission to oversee a return to full relations.
Cuba reopened its embassy in Washington last month.
Cuban leader Raul Castro and US President Barack Obama agreed to restore ties in December last year.
While trade and travel restrictions have been relaxed, the Republican-led US Congress has not lifted the trade embargo the US imposed on the communist-run island in 1960.
Mr Kerry's visit to Cuba drew criticism from several leading Republicans, including presidential candidate Jeb Bush who said it was "a birthday present for Fidel Castro - a symbol of the Obama administration's acquiescence to his ruthless legacy".
He and Marco Rubio, another presidential contender and Cuban-American senator in Florida, also criticised the US secretary of state for not inviting Cuban dissidents to the ceremony. Mr Kerry said he was due to meet dissidents at a private event later on Friday.
Cuba says relations will be fully restored only once the embargo is lifted.
Fidel Castro: Cuba's revolutionary leader
- Castro survived over 600 assassination attempts to become the longest serving non-royal leader of the 20th Century
- In 1959 he took power in the Cuban Revolution after several years of guerrilla warfare in the mountains
- The CIA sponsored an unsuccessful invasion by 1,500 Cuban exiles at the Bay of Pigs in 1961. Castro took personal charge of the defensive operation
- In 1962 the Cuban Missile Crisis brought the world to the brink of nuclear war
- 125,000 Cubans emigrated to the US in the Mariel Boatlift in 1980
- In 2008 Castro stepped down from power and handed over the reins to his younger brother Raul.
Fidel Castro's letter was published in state newspaper Granma to mark his 89th birthday.
In it, Mr Castro said Cuba was committed to "good will and peace in our hemisphere" but added: "We will never stop fighting for the peace and welfare of all human beings, regardless of the colour of their skin and which country they come from."
Fidel Castro led his country from the Cuban Revolution, in 1959, until 2006, when he stood down because of undisclosed health problems.
He passed on power to his younger brother, Raul, who embarked on a number of economic reforms.