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Avinash Dixit is John J.F. Sherrerd’ 52 University Professor of Economics at Princeton University. He received his Ph.D. from the Massachusetts Institute of Technology and has held faculty positions at the Universities of California (Berkeley), Oxford, and Warwick. He was a Visiting Scholar in the Research Department when this paper was written. The author thanks Matthew Canzoneri, Nurun Choudhry, Pablo Guidotti, Lars Svensson, and Carlos Végh for useful comments.