Why would anyone want local address to be served by proxy anyway? Shouldn't it be hardcoded as true for this setting? Why is this setting at all? Whats the use case of wanting to have your local addresses served by proxy? Does proxy understand localhost anyway?
It isn't about Local Host, it is about Local meaning intranet/internal sites and non (standard) internet.
Internet explorer will automatically attempt to identify sites, but, you can configure them in the
Anything here, combined with the option in the proxy server tab will mean that if you are accessing sites from within your network, it will not connect via the proxy server.
Some more advanced/complex setups I have seen in offices have an edge proxy server which can only access outside resources and has no access to internal resources meaning that you need to use this setting.