raising revenue--such as an income tax--entail distortions. Hence, the benefit from surprise inflation depends again on some existing externality Calvo (1978) discusses the sity of existing distortions in this type of model The revenue incentive for surprise inflation relates to governmental liabilities that are fixed in nominal terms, rather than to money, per se Thus, the same argument applies to nominally-denominated, interest-: public debt. Suppose that people held last period the real amount of gov ernment bonds, B. /P t-1/P+1. These bonds carry the nominal yield, t-1,which is satisfactory given people's inflationary expectations over the pertinent horizon, Surprise inflation, e, depreciates part of the real value of these bonds, which lowers the government's future real expenditures for interest and repayment of principal. In effect, surprise inflation is again a source of revenue to the government. Quantitatively, this channel from public debt is likely to be more significant than the usually discussed mech- anism,which involves revenue from printing high-powered money. For example, the outstanding public debt for the U.s. in 1981 is around $l trillion. Therefore, a surprise inflation of 1 per cent lowers the real value of this debt by about $10 billion. Hence, this channel produces an effective lump amount of revenue of about $10 billion for each extra 1% of surprise inf la tion. By contrast, the entire annual flow of revenue through the Federal Reserve from the creation of high-powered money is about the same magnitude ($8 billion in 1981, $13 billion in 1980) The attractions of generating revenue from surprise inflation are clear if we view the depreciation of real cash or real bonds as an unexpected capital levy. As with a tax on existing capital, surprise inflation provides for a method of raising funds that is essentially non-distorting, ex post-4- raising revenue--such as an income tax--entail distortions. Hence, the benefit from surprise inflation depends again on some existing externality. Calvo (1978) discusses the necessity of existing distortions in this type of model. The revenue incentive for surprise inflation relates to governmental liabilities that are fixed in nominal terms, rather than to money, E!!. • Thus, the same argument applies to nominally-denominated, interest-bearing public debt. Suppose that people held last period the real amount of gov￾ernment bonds, Bti/Pti. These bonds carry the nominal yield, Rti, which is satisfactory given people's inflationary expectations over the pertinent e e horizon, • Surprise inflation, depreciates part of the real value of these bonds, which lowers the government's future real expenditures for interest and repayment of principal. In effect, surprise inflation is again a source of revenue to the government. Quantitatively, this channel from public debt is likely to be more significant than the usually discussed mech￾anism, which involves revenue from printing high-powered money. For example, the outstanding public debt for the U.S. in 1981 is around $1 trillion.1 Therefore, a surprise inflation of 1 per cent lowers the real value of this debt by about $10 billion. Hence, this channel produces an effective lump amount of revenue of about $10 billion for each extra 1% of surprise infla￾tion. By contrast, the entire annual flow of revenue through the Federal Reserve from the creation of high-powered money is about the same magnitude ($8 billion in 1981, $13 billion in 1980). The attractions of generating revenue from surprise inflation are clear if we view the depreciation of real cash or real bonds as an unexpected capital levy. As with a tax on existing capital, surprise inflation provides for a method of raising funds that is essentially non-distorting, ex post