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.