In this paper, we investigate the effects of relative price variability on output and the stock market and gauge the extent to which inflation proxies for relative price variability in stock return-inflation regressions. The evidence shows that the negative stock returninflation relations proxy for the adverse effects of relative price variability on economic activity, particularly during the seventies, when the U.S. experienced oil supply shocks. Hence, it appears that inflation spuriously affects the stock market in two ways: the aggregate output link of Fama (1981) and the supply shocks reflected in relative price variability. A NUMBER OF PAPERS have attempted to explain the anomalous negative relations between stock returns and inflation witnessed in the post-war period. One hypothesis that has held up well in light of empirical evidence suggests that the negative relation between stock returns and unexpected inflation simply reflects the more fundamental positive relation between stock returns and future real variables (see, e.g., Fama (1981), Geske and Roll (1983), and Kaul (1987, 1989)). In this paper, we investigate the effects of relative price variability on output and the stock market and gauge the extent to which inflation proxies for relative price variability in stock return-inflation regressions. First, relative price variability can have detrimental effects on output and employment (see, e.g., Friedman (1977) and Barro (1976)). Second, absolute-relative price confusion models of the Lucas (1973) type suggest that monetary shocks can induce a positive relation between inflation and relative price variability (see, e.g., Cukierman (1983)). Hence, the negative stock return-inflation relations could simply be a reflection of the negative effects of relative price variability on the stock market. We use data for the 1947-1985 period to test the various links of our hypothesis. The results indicate that relative price variability is positively related to both expected and unexpected inflation measures. Relative price variability also has a significant negative effect on output and the stock market. More importantly