Is the Cost of Living and Inflation Higher in Washington-Baltimore Area?

by Anirban Basu 18. July 2011

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
State Cost of Living 2010The 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

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.

Maryland's Economy: There is Still Plenty of Reason for Concern, but the Reasons Have Changed

by Anirban Basu 15. April 2011

Focus Shifts from Growth to Inflation

Economy Now Enjoys Self-Sustaining Momentum

Coming into 2011, economists remained largely fixated on the inadequacy of demand for labor, housing, commercial real estate and other aspects of economic life. Economists have been busily pouring over reams of data regarding senior bank loan officer attitudes, consumer credit availability and other indicia of credit market thawing. The conventional wisdom has been that until banks begin lending more aggressively, the U.S. economy will continue to be lackluster and the recovery that began in mid-2009 will remain fragile.

With the first quarter now over, many of the principal economic concerns coming into the year have been largely addressed. For instance, demand is building. Retail sales are up 9.5 percent on a year-over-year basis through February. Overall consumer spending is up 2.5 percent with the purchase of durable goods up 11.9 percent on an inflation-adjusted basis. Adjusted for inflation, private nonresidential fixed investment was up 1.9 during the fourth quarter and 10.6 percent year-over-year.

Moody’s presently predicts that consumption will expand 3.3 percent in 2011, with motor vehicle sales rising 13.6 percent. Fixed investment is predicted to rise nearly 9.6 percent this year, with investment in equipment up 10.3 percent.

Foreign demand has also been strong. Despite a sea of troubles ranging from Portugal to Japan and engulfing Tunisia, Egypt, Libya, Greece, Yemen and Pakistan, the world increasingly looks to America for output. That is very encouraging. Since January 2010, U.S. exports are up 6.9 percent on a seasonally adjusted basis and 18.9 percent on a not seasonally adjusted basis, with sales to China, India and Brazil up 17.3 percent, 42.2 percent and 7.4 percent, respectively.

The accompanying increase in production has led to the emergence of a new trend in America: employment growth in manufacturing. For six months running, the number of manufacturing jobs in America is up on a year-over-year basis, with March 2011 industry employment totals 196,000 jobs above the corresponding month one year prior.

Employment growth has generally been accelerating in America. Nonfarm payroll employment increased by 216,000 in March according to the Bureau of Labor Statistics (BLS) and the nation’s unemployment ticked down to 8.8 percent. BLS observed job gains professional and business services, health care, leisure and hospitality and mining. However, the number of long-term unemployed (those jobless for 27 weeks or more) totaled 6.1 million in March and their share of the unemployed increased from 43.9 percent to 45.5 percent over the course of the month.

All of this positive economic news has allowed equity markets to bounce higher. At the beginning of the year, the Dow Jones Industrial Average stood at 11,577. By the end of March, the Index stood at 12,320 and as of this writing has risen above 12,400. The S&P 500 is up 6.0 percent since the beginning of the year. That’s simply remarkable in light of the tragedies in Japan, sovereign debt issues in Europe, civil war in Libya and oil prices that are now above $110 a barrel.

Inflationary Pressures Have Been Building

For months, we have been suggesting that it is still too soon to tell whether or not inflation will become problematic. Indeed, recent core inflation data (all components except food and energy) indicate that inflation remains mild. Through February, core inflation was running at a 0.2 percent monthly rate and 1.1 percent annual rate in America despite increases in medical care expenses (up 0.4% for the month and 2.9 percent year-over-year).

That said, inflationary buzzards have begun to circle. There are a number of factors that collectively conspire to support the emerging view that at some point later this year or in 2012 the U.S. Federal Reserve will begin to find it necessary to constrain inflationary pressures by reducing money supply growth and increasing short-term rates.

While much of the recent focus has been upon food and energy prices, commodity prices generally have been marching higher. For instance, steel and iron producer prices are up 16.8 percent through February on a year-over-year basis. Gold now stands at $1,471 a troy ounce, up 27.9 percent from a year ago. Cotton prices recently set a record at $2.11 a pound. Certain non-commodity prices have also been drifting higher, including airline fares, which are up 12.3 percent year-over-year through February.

What’s more, import prices are also up with a growing number of nations reporting widening inflationary issues. In India, inflation is up 18.9 percent year-to-date through February. In China, the corresponding statistic is 10.0 percent. In Mexico, consumer prices are up 10.8 percent through March. Presumably, this inflation will continue to be exported to America in the form of higher priced clothing, food and household items.

Thus far, many prices have been constrained due to productivity gains and the inability of producers to pass along input price increases (including those associated with oil prices) to consumers. But with the economy steadily improving, consumers are likely to face rising prices for many goods and services, and that will ultimately prompt the Federal Reserve to begin to meaningfully chip away at the massive monetary accommodation it has been providing to the economy in the wake of the financial crisis that gripped us in September of 2008 and the accompanying Great Recession.

Implications for Investors

It has been wonderful to be exposed to equities over the past two years. The Dow Jones Industrial Average is up roughly 92 percent since its March 9, 2009 intraday low. The simple laws of gravity suggest that at some point, some of these gains will be returned. But the specter of inflation is now becoming more apparent, with the primary implication being that the current interest rate environment is about to shift. That would impact the multiple on corporate earnings and therefore stock prices.

Emerging inflationary pressures render bond investing particularly challenging. Even in the absence of inflationary pressures, bond market fluctuations have been unusually difficult to predict. Sovereign and municipal debt issues have unnerved many investors and yields have been drifting higher on various forms of debt. As of this writing, the yield on the 10-year U.S. Treasury stands at 3.59 percent, up 41.3 percent from early November 2010.

On top of that, commodities have enjoyed a remarkable run as well. It is unlikely that this can continue in conjunction with an ongoing equity market rally. To put it in the simplest terms, something has got to give. Therefore, while underlying positive economic momentum implies that substantial exposure to equities remains sensible as we approach mid-year 2011, investors should be thinking about quick response strategies to a potential market correction that could be triggered by bad news regarding core inflation.

Anirban Basu is Chairman & CEO of Sage Policy Group, Inc., an economic and policy consulting firm in Baltimore, Maryland. Mr. Basu is one of the Mid-Atlantic region’s most recognizable economists, in part because of his consulting work on behalf of numerous clients, including prominent developers, bankers, brokerage houses, energy suppliers and law firms. On behalf of government agencies and non-profit organizations, Mr. Basu has written several high-profile economic development strategies, including co-authoring Baltimore City’s economic growth strategy. His opinions do not necessarily reflect the opinions and beliefs of 1st Mariner Bank.

Crystal Balls, Ouija Boards, and Basu? What's the 2011 Maryland Economic Prediction?

by Anirban Basu 27. January 2011

Equity Markets and Economy Have Turned for the Better

Why Economic Activity may not Accelerate as Dramatically as Expected this Year

A combination of ongoing stimulus and recent economic momentum has induced many economists to ratchet up their 2011 forecasts and there are plenty of reasons to be optimistic.  Consumer spending has been rising, with retail and food services sales up 7.7 percent between November 2009 and November 2010.  Auto sales have also been edging higher, including among America’s big three automakers.  The holiday shopping season was the best in several years.

It also helps that financial markets have been recovering.  On March 9th of 2009, the Dow Jones Industrial Average sank to 6,469.95 intraday.  As of this writing, it stands at well above 11,600.  Since financial market performance often foreshadows broader economic performance, the implication is that the economy is in for some better times ahead.

While it is true that 2011 is very likely to be a year a solid growth, it is possible that members of the dismal science have become a bit too optimistic in their projections in recent months.  There are (at least) ten factors that could act as speed governors on the U.S. economy this year.

  • Consumers tap their brakes

Though household spending was unexpectedly strong in 2010, in the absence of substantial income growth, this is unlikely to continue particularly if consumers are spooked by unemployment rates that still hover near double digits.  Many consumers may feel buyers’ remorse during this year’s first quarter as credit card statements tumble in.

  • Housing market recovery scrubs much of its speed 

The fear had been that once the first-time and move-up buyer tax credits expired, the housing market would begin to swoon.  That is precisely what happened, with existing home sales slumping since May and new home sales performing even more sluggishly.

  • Federal spending cuts diminish momentum 

Congress has not been as serious about deficit reduction since arguably the early 1990s.  Already, the newly-seated Congress is talking seriously about substantial cuts to discretionary spending, including within the Department of Defense budget.

  • State/local tax increases become a source of slippage

At least 46 states struggled with fiscal shortfalls when adopting budgets for the current fiscal year, which in most states began July 1st.  The collective budgetary gap for 2011 and 2012 is $260 billion.

  • The stimulus turbocharger cuts off

Though much of the $787 billion associated with the American Recovery and Reinvestment Act of 2009 has yet to be spent, by some point in 2011, the federal stimulus driver will begin to wind down, and that remains another reason to believe that another economic downturn could be headed our way.

  • European debt crisis is no formula for success

Greece, Portugal and Spain have all experienced debt downgrades.  Greek debt has now reached junk status.  Though members of the European Union have established a $1 billion bailout fun, there is still the possibility of a sovereign default going forward.  Nearly 100 European banks are being stress tested.

  • State and local government spending further deflates aggregate demand

Despite ongoing assistance from the federal government, it is clear that most state and local governments have begun to decelerate spending.  While there is something positive associated with the rationalization of spending levels, in the short-term the impact is negative including upon contractors.

  • Government spending cuts in other parts of the world puts global expansion into neutral 

At the most recent G-20 summit, nations from around the globe agreed to slash their deficits over time.  A number of countries in Europe, including Greece and Spain, have initiated austerity programs through a combination of tax increases and spending adjustments.  Not surprisingly, recent data indicate that global economic expansion is beginning to soften.

  • Bond market continues to fade

Bond traders have become increasingly unnerved by sovereign debt issues, growing fears of inflation and the temptation to leave fixed-income assets for equities.  If the bond market continues to experience outflows, interest rates could rise further, slowing economic progress in the process.  According to Barron’s, bond mutual funds redeemed nearly $15 billion in December, the heaviest outflow since October 2008.

  • Unemployment remains high and private job growth has not picked up sufficiently 

The key to sustained economic momentum is income growth.  With employment growth still lagging and with the public sector now retrenching, the prospects for a significant acceleration in wage/salary income growth next year are weak.

Looking Ahead

Despite these risks to the economic outlook, this year is shaping up to be a good one for the U.S. and Maryland economies.  The nation’s economy is positioned to expand at 3 percent or better adding an estimated 1.6 million jobs in the process.  Unemployment should be closer to 9 percent by the end of the current year.  Maryland is positioned to add more than 40,000 jobs this year, respectable performance by historic standards.

Based on that, more substantial exposure to equities appears warranted.  Though investors must always remain vigilant, there is now more transparency regarding the direction of the U.S. economy than there has been for several years, and that has been and likely will be good for stocks in general.

Anirban Basu is Chairman & CEO of Sage Policy Group, Inc., an economic and policy consulting firm in Baltimore, Maryland. Mr. Basu is one of the Mid-Atlantic region’s most recognizable economists, in part because of his consulting work on behalf of numerous clients, including prominent developers, bankers, brokerage houses, energy suppliers and law firms. On behalf of government agencies and non-profit organizations, Mr. Basu has written several high-profile economic development strategies, including co-authoring Baltimore City’s economic growth strategy. His opinions do not necessarily reflect the opinions and beliefs of 1st Mariner Bank.

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