You hear a lot of economic statistics that come in with the proviso that they are adjusted for inflation. What exactly does that mean, and if you take out inflation, are we really in a housing bubble?

Definitions differ as to whether inflation is a cause or an effect, but two elements are always present -- consumer goods cost more and currency is devalued.

The result is a "persistent increase in the level of consumer prices or a persistent decline in the purchasing power of money, caused by an increase in available currency and credit beyond the proportion of available goods and services," as defined by Webster.

According to the calculations by Inflationdata.com, inflation has averaged about 3.49 percent annually since 1914. That means it is significantly higher some years, and lower other years. From 2000 to 2004, inflation has been a full percentage point lower than the norm, about 2.5 percent on average.

In 2005, inflation picked up but only slightly for the year -- 3.4 percent on consumer goods, compared to a rate of 3.3 percent in 2004, which puts 2005 closer to the 3.5 annual average.

When inflation goes up, so does the cost of money, as the Federal Reserve raises short-term interest rates to cool inflation down. Since banks loan money in order to make a profit, long-term rates typically rise, too.

In relating inflation to housing data, it's interesting to note that housing prices have risen steadily every year since the National Association of Realtors began keeping track back in the mid-1960s. In 2005, housing rose four percent.

During the 12 month period ended in December, the indexes for lodging away from home, for rent, and for owners' equivalent rent, rose 3.5, 3.1, and 2.5 percent, respectively, indicating that housing is still ahead of inflation for the time being, but not by much.

Published: January 31, 2006

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