This ought to be a no-brainer. Consumers are struggling to pay their food and gas bills, the major commodities indexes have soared by more than 25% since January and rising raw materials costs are squeezing many manufacturers' profits. A weak dollar makes imports more expensive every day, and the Federal Reserve chairman is hinting at hiking interest rates. So we're in an inflationary cycle, right?

Well, sort of. Although in some economic sectors it feels eerily like the 1970s, there are differences this time that make it tough to predict whether the painful price rises are the beginning of a long, nasty trend. That uncertainty makes an advisor's job tougher than usual, and there's little consensus about how to calm jittery clients. Some advisors are baking higher inflation assumptions into financial plans and rejiggering portfolios, while others, who believe that anemic growth presents the bigger challenge, are staying the course.

Several factors make that decision a hard call. One is controversy over which is more reliable: headline inflation, which includes food and energy prices, or core inflation, which strips them out. The gap between the two measures has widened over the past five years. Now some economists—including those at the Fed—are beginning to think that core inflation, currently used to make monetary policy decisions, doesn't reflect what's really going on with consumer prices.

The original point of leaving food and energy out of the core consumer price index, or CPI, was that the availability of commodities like wheat and oil tends to be more seasonal and volatile than other cost-of-living components such as housing. In the past, that volatility was usually driven by supply shocks, such as Organization of Petroleum Exporting Countries pronouncements or extreme weather conditions. The worry is that today's food and energy prices are driven by demand forces. Brazil, Russia, India, China (the BRIC nations) and other fast-growing economies need exponentially more grain and fuel each month, and some economists believe that need will keep prices up indefinitely. If so, then headline inflation number may be the one to watch. Fed governors appear to be leaning toward this point of view, but not all experts agree. "Food and energy prices have boosted headline inflation, and we are seeing higher commodity and raw materials prices," says Scott Brown, chief economist at Raymond James. "But there's little flow-through by the time you get to the consumer. Advertising, packaging and labor-which is the biggest expense-aren't rising that fast."

Brown's point goes to the heart of the second controversy surrounding U.S. inflation: the role of wages. Historically, an inflationary cycle began when workers demanded pay increases to keep up with rising prices, and companies passed higher payroll costs on to consumers in the form of price hikes. Currently, though, employees have little power to get raises. Thanks to tens of thousands of layoffs in industries from autos to finance, workers are happy just to keep their jobs. U.S. unemployment reached 5.7% in July, while average hours worked and weekly pay continued to fall. So, since wages account for around 70% of input costs for goods and services, many economists believe this driver of inflation is dormant. "The global glut of cheap labor is not allowing commodity costs to be passed to consumers," says Scott Wren, senior equity strategist at Wachovia Securities. He contrasts 21st-century economics with the 1970s, when wages moved in lockstep with commodity prices, thanks to the clout of strong labor unions. Today, "there's not a lot of pricing power out there." (Wachovia is forecasting minimal wage pressure and commodity prices that are flat to down over the next 12 months. "Headline inflation will fall back toward core," Wren predicts.)

External forces push up prices too. As living standards rise in BRIC countries, workers there are asking for better pay—and in superheated economies, they have the leverage to get it. Their raises lead to higher export prices. So does China's strengthening currency, which the government formerly kept artificially weak against the dollar. As for commodity prices, many market watchers don't think global demand will soften any time soon.

Twin Crises

"We're very concerned about inflation," says Jonathan Bergman, chief investment officer at Palisades Hudson Financial Group, a fee-only advisory firm with $1.3 billion under management, headquartered in Scarsdale, N.Y. and Fort Lauderdale, Fla. "We think the risks have changed dramatically." Bergman fears that with the twin crises in housing and mortgage finance, the Fed has little leeway to raise interest rates. "That means persistent high inflation is on the horizon," he says.