Small Towns, Big Cities, Shared Inflation

How does inflation differ across rural and urban areas of the United States? One analysis shows significantly higher inflation in rural areas versus urban areas while looking at broad regions, but is this also true when drilling down to the state level?

A recent analysis by the Congressional Budget Office (CBO) found that rural areas have experienced higher inflation than urban areas since the start of the pandemic. Consumer price inflation in rural areas averaged 4.8 percent annualized from the fourth quarter of 2019 through the fourth quarter of 2021, compared to 3.7 percent in urban areas over the same period.

Because no price data are released that explicitly distinguish between rural and urban inflation, the CBO used statistical methods to impute rural versus urban inflation from regional inflation and demographic data published by the Bureau of Labor Statistics. These data provide a view of inflation across nine broad census divisions: New England, Middle Atlantic, East North Central, West North Central, South Atlantic, East South Central, West South Central, Mountain and Pacific.

In this post, we conduct a similar analysis using data at the state level. However, instead of using the Consumer Price Index for All Urban Consumers (CPI-U), we measure inflation in each state using GDP deflator data from the Bureau of Economic Analysis. Following the CBO's approach, we did the analysis in two steps:

• In the first step, we identified a statistical relationship between national (GDP deflator) inflation and inflation within each state using quarterly data over the period 2010-2021.
• In the second step, we examined how that relationship implicitly varies with the fraction of people living in rural areas for each state, allowing us to roughly estimate how inflation in rural areas differs from urban inflation.

Our approach has two potential advantages. First, by using GDP deflator information from all 50 states, we get even more information about how inflation varies across urban and rural areas compared to using CPI inflation data from nine broad regions. This allows us to break out the urban/rural contributions to inflation with more precision.

Secondly, the GDP deflator captures the entire state (in principle), in contrast to the CPI which mostly focuses on urban areas. However, as noted in the CBO study, the CPI sample covers areas where 15 percent of people reside in rural places.

As seen in Figure 1 below, rural areas have experienced consistently higher inflation compared to urban areas throughout the pandemic.

Although the GDP deflator provides one measure of price-level growth, the Fed's preferred measure of inflation is the Personal Consumption Expenditures (PCE) price index, not the GDP deflator. Conceptually, the two price indexes measure different things:

• The PCE price index captures the changing prices faced by consumers.
• The GDP deflator measures changes in the prices of all goods and services produced domestically (or in states, in our case).

How much does this matter in our analysis? Figure 2 below shows year-over-year percent changes for the national GDP deflator and PCE price index since 1980, showing the two have tracked very closely together.

Since 1980, the average difference between the two series has been only 4 basis points. Since the onset of COVID-19, that gap has widened somewhat, with the GDP deflator running higher than PCE inflation by about 20 basis points on average. This means our GDP deflator-based inflation measure could be considered an upper bound for recent consumer price inflation.

Our analysis shows that between the fourth quarter of 2019 and the fourth quarter of 2021, urban inflation has run at a 2.8 percent annualized pace, while rural inflation has run at a 3.2 percent annualized pace. Our estimates are lower than those of the CBO, which may reflect the choice of different inflation measures. The CBO looks at CPI inflation, which doesn't account for consumers' ability to substitute cheaper products for more expensive ones, whereas our measure is more similar to the PCE price index which allows for substitution.

Still, both analyses support the view that the rural experience of inflation has been more severe in the aftermath of COVID-19. Rural communities may be disproportionately affected by the current strong rise in prices.