The Difference between Inflation and Cost of Living

Inflation is defined as an increase or change in the general price level. Generally, inflation is viewed negatively since (all things being equal) an increase in prices reduces purchasing power. The cost of living can be understood as the general price level itself. In other words, a place that is terribly inexpensive to live in can be associated with high inflation, though if that high inflation persists, that place will not remain inexpensive. Conversely, an area that is expensive can be associated with low inflation.

• Maryland is an Expensive Proposition

Data indicates that Maryland and the Washington-Baltimore area are associated with both a high cost of living and higher rates of inflation than national averages. For instance, 43 states were associated with a lower cost of living than Maryland during the final quarter of 2010 according to the Council for Community and Economic Research (Exhibit 1). Maryland’s overall cost of living is roughly 25 percent higher than the national average, housing is 69 percent more expensive and utility costs are 17 percent higher. Transportation and grocery costs are also higher in Maryland by 8 and 10 percent, respectively.

Exhibit 1. State Cost of Living Rankings, Fourth Quarter 2010

The recent housing downturn, which has been disproportionately felt on the coasts, has both reduced inflation and diminished the difference in cost of living with the balance of the nation more recently. Consumer prices excluding food and energy expanded 1.9 percent in 2009 in the Washington-Baltimore region and just 1.4 percent in 2010. According to the Federal Reserve Bank of Richmond, the average value of homes in Maryland has declined 21.4 percent since 2007. This has reduced the overall pace of inflation.

However, inflation ran at more than a 2 percent pace during the first three months of 2011 locally, in part a reflection of growing pricing power among area businesses. Between May 2010 and May 2011, core prices in the Washington-Baltimore area climbed 2.3 percent compared with 1.5 percent nationally.

Exhibit 2. Core CPI Growth by Select Metropolitan Area, 2000 v. 2010

Bureau of Labor Statistic

Implications

Despite the recent and ongoing housing downturn, Maryland remains an expensive proposition. Like other Americans, Marylanders have had to deal with a host of rising costs, including food and energy prices.

Indeed, Moody’s Analytics cites high business costs as being one of Maryland’s biggest obstacles to recovery. Operating costs are higher in Maryland because businesses consume pricey energy and transportation. Moreover, the overall higher cost of living necessitates higher wages, which creates further operating cost disadvantages.

This may help explain Maryland’s lackluster job creation in recent months, which has significantly underperformed the nation. One of the questions for state and local policymakers is whether or not there are possible shifts in policy that would help reduce business operating costs without generating substantial harm to quality of life.