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By Naomi Caine

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Has the government got it wrong again? I am not talking about its policy in the Middle East or Tony Blair's exit strategy, but about inflation.

If you are following official price rises you will know that inflation went up in June to 2.5%, although it fell back a bit in July to 2.4%.

Inflation is running ahead of the Bank of England's target of 2%, but it's still pretty low. So why does everything seem so expensive these days? Has the government got its figures wrong?

Well, yes and no. The inflation figure is based on the Consumer Prices Index (CPI), which is compiled using a "typical" shopping basket of 650 goods and services. The items in the basket are also given a weighting. The average household apparently devotes 9% of its total spending to food and 2.7% to package holidays.

Critics argue that the CPI is biased towards cheaper goods such as clothes and CD players, rather than more expensive services such as transport and childcare. Private school fees, for example, are up nearly 6% over the past year. The cost of a nanny is also rising above the rate of inflation, at 4%. And petrol prices have soared about 10% as the cost of oil has jumped.
The typical weightings might also bear little relation to your own spending habits. Tim Cockerill, head of research at Rowan, an independent financial adviser (IFA), says: "The government's basket of goods is pretty comprehensive, but it's the weightings that really matter. If you spend a large portion of your income on energy bills, for example, you will have a much higher inflation rate than the official figure."

The cost of energy is up more than 25% this year as consumers have struggled with more than one price hike. The elderly spend a bigger portion of their income on energy than the rest of us, so it's perhaps no surprise that pensioner inflation is running at 3.9%, the highest in a decade, according to research by Clerical Medical.

If the items and their weightings did not already skew the figures enough, there's the CPI's big omission: it does not include the costs of running a home such as council tax and mortgage interest. Now, my council tax bill is undoubtedly rising faster than inflation - and house prices might be slowing but they have certainly gone up by more than 2% a year over the past few years.
The old Retail Prices Index was better - and the current rate is 3.3%. But even that's a tad low.

Cockerill thinks we should all have our own personal rate of inflation. If so, you might find it's running at more than double the official figure. Professor Richard Scase of the University of Kent reckons that inflation for the average middle-class family is 10%.
It would all be academic, if the CPI were not used as a basis for monetary policy. The Bank of England's monetary policy committee (MPC) pushed up interest rates when inflation started to overshoot the target in the summer. But was it too little too late? And could the MPC be wrongfooted by the apparent fall in inflation?

Of course, we all know when prices have gone up, but there's a hidden, darker side to inflation: it gradually eats into your savings. And the figures are quite scary.

Inflation at 2% will erode the value of £5,000 to £4,712 after three years, or £4,529 after five years. If the return on your money is less than inflation you may as well spend it all now because it will only buy less in future.

And that's with inflation at 2%. Think what's happening to your money if your personal rate is running at 5%, or even 10%.
It certainly makes life tricky for higher-rate taxpayers. If you pay tax at 40%, you need to earn at least 5.5% to beat tax and inflation, using the RPI figure of 3.3%. Sadly, there are no savings accounts that are up to the job, according to Sue Hannums at AWD Chase de Vere, an IFA. None.

Basic-rate taxpayers need to earn at least 4.13% and they at least get some choice. The best deals are 5.1% on Yorkshire building society's internet saver account, or 5.05% from Anglo Irish Bank. If you can tie into a fixed-rate bond, Halifax is paying 5.55% for three years. Or you can get 5.5% at Birmingham Midshires for one year.

You should also make full use of your tax-free Isa allowance. You can put up to £3,000 a year into a mini cash Isa and the current best buy is from National Savings & Investments at 5.3%. You are still at the mercy of inflation, but at least you don't have to pay tax

I would then have a look at Index Linked Certificates, also from National Savings & Investments. They really are a good deal because they are tax-free and guaranteed to beat inflation. The three-year certificate pays tax-free interest of 1.05% a year above RPI, so 4.35% at the moment. That's equivalent to a gross rate of 5.43% for a basic-rate taxpayer and 7.25% for someone on the higher rate.

There are also five-year certificates that pay 1.1% above inflation, to give a gross equivalent rate of 7.33% for a top-rate payer and 5.5% on the basic rate.