Stock returns, inflation, and the ‘proxy hypothesis’: A new look at the data

This paper reexamines the proxy hypothesis of Fama ( American Economic Review, 1981, 71, 545–565) as the main explanation for the negative correlation between stock returns and inflation. We look at quarterly data on industrial-production growth, monetary-base growth, CPI inflation, three-month Treasury-bill rates, and returns on the equally-weighted NYSE portfolio, for the 1954–1976 and 1977–1990 periods. Using time-series techniques, we find that production growth induces only a weak negative correlation between inflation and stock returns, and explains less of the covariance between the two series than inflation and interest-rate innovations.