Two hundred sixty-three consecutive medical inpatients were studied to assess whether depression and anxiety are associated with increased costs and reduced health-related quality of life. Seventy-three (27.8%) had depressive/anxiety disorders, 107 were "subthreshold" cases, and 83 were controls. After adjustment for severity of physical illness, using the Duke Severity of Illness Scale, cases and subthreshold cases incurred greater mean health care costs than controls over the follow-up period: $8,541 (SE = $605) versus $5,857 (SE = $859), P = 0.012. There was significant impairment of health-related quality of life (SF36 scores) in cases and, to a lesser extent, in subthreshold cases compared to controls. This impairment persisted at follow-up, as did anxiety and depression, indicating the need for future intervention studies.