Is it inflation or just a price increase?

• Author: Adams, Tucker Hart
• Position: The ECONOMIST - Trends in consumer price indexes

"You economists just don't understand what's important," said the photographer, settling down for a chat after an hour of PR shots. "It's not inflation that people are worried about. It's that prices are going up."

That conversation occurred in my office in 1981, when the nation was in the grip of its third year of double-digit inflation rates. The metro Denver area Consumer Price Index rose 15.5 percent in 1979, 12 percent in 1980 and 11.2 percent in 1981. Short-term interest rates were above 20 percent; mortgage rates were as high as 18 percent; and 15 percent to 20 percent salary increases for a valued employee were common, indeed expected.

Despite his lack of understanding of the definition of inflation, the photographer was onto something.

The Consumer Price Index (CPI) is a measure of the average change over time in the prices paid for a market basket of consumer goods and services. It is based on detailed expenditure information last updated in 2001 and 2002, provided by families and individuals living in urban areas on what they actually bought. Each month, data collectors from the Bureau of Labor Statistics visit or call thousands of retail stores, service establishments, rental units and doctors' offices all over the United States to obtain information on the prices.

Expenditure items are classified into more than 200 categories, arranged into eight major groups. Various government-charged user fees such as auto registration and vehicle tolls are included, along with sales and excise taxes.

Have you ever wondered how much the average household spends on gasoline? About 4.3 percent of expenditures. Fresh fish? 0.2 percent, twice what they spend on coffee and a bit more than on ice cream. Six percentage points of our food budget goes to food away from home. We're a nation that loves to eat out.

Through November 2007, inflation, as measured by the CPI-U, rose 4.3 percent. The Federal Reserve's favorite measure, core inflation--which excludes food and energy and is meaningful to anyone who doesn't eat, drive or heat a home--rose only 2.3 percent.

We are constantly reassured that inflation is under control, that the Federal Reserve can cut interest rates to ward off recession. This is where my photographer friend got it right. It's not inflation that you and I are worried about, it's the fact that prices are going up.

Almost a quarter of the CPI-U is comprised of something called owner-equivalent rent. It was introduced a couple of...