Stimulus encoding by primary sensory brain areas provides a data-rich context for understanding their circuit mechanisms. The vertebrate olfactory bulb is an input area having unusual two-layer dendro-dendritic connections whose roles in odor coding are unclear. To clarify these roles, we built a detailed compartmental model of the rat olfactory bulb that synthesizes a much wider range of experimental observations on bulbar physiology and response dynamics than has hitherto been modeled. We predict that superficial-layer inhibitory interneurons (periglomerular cells) linearize the input-output transformation of the principal neurons (mitral cells), unlike previous models of contrast enhancement. The linearization is required to replicate observed linear summation of mitral odor responses. Further, in our model, action-potentials back-propagate along lateral dendrites of mitral cells and activate deep-layer inhibitory interneurons (granule cells). Using this, we propose sparse, long-range inhibition between mitral cells, mediated by granule cells, to explain how the respiratory phases of odor responses of sister mitral cells can be sometimes decorrelated as observed, despite receiving similar receptor input. We also rule out some alternative mechanisms. In our mechanism, we predict that a few distant mitral cells receiving input from different receptors, inhibit sister mitral cells differentially, by activating disjoint subsets of granule cells. This differential inhibition is strong enough to decorrelate their firing rate phases, and not merely modulate their spike timing. Thus our well-constrained model suggests novel computational roles for the two most numerous classes of interneurons in the bulb.