Views about the Irish economy have become noticeably more upbeat of late. Not only are professional forecasters revising their numbers upwards but the ordinary punter is also getting more optimistic.

Therefore, the October reading of the IIB-ESRI Consumer Sentiment Index registered an increase for the third month in a row.

This shift in sentiment seems to reflect the influence of news from the United States. Its latest batch of indicators has been strongly positive. The net effect has been to suggest that a previously tepid and jobless economic recovery has morphed into something much more robust and employment friendly.

It is estimated that gross domestic product (GDP) expanded in the third quarter at a 7.2 per cent annualised rate and payrolls rose by an average 125,000 per month between August and October.

The instinct to interpret good third-quarter US data as the harbinger of better times for the Irish economy is understandable (a strong US economy is probably a necessary condition for a strong recovery in the Republic), but it rests on some assumptions that merit closer scrutiny.

The first assumption is that the stronger pace of recovery in the US can be sustained. The other is that, if sustained, a decent US recovery will stimulate economic activity in Europe generally and in the Republic in particular, and that a strong US recovery is a sufficient condition for a strong recovery here.

Will faster US growth be sustained? Well, not at its third-quarter pace, that's for sure. The 7.2 per cent growth chalked up in that quarter was mainly due to a surge in consumer spending - the result of big tax refunds and mortgage refinancing at lower interest rates. These are, to a large extent, once-off stimuli.

It is a virtual cast-iron certainty that the US's growth rate in the fourth quarter will be significantly slower. However, this does not preclude the possibility that US GDP might grow by up to 4 per cent per annum in 2004 and 2005.

The biggest obstacle to this kind of prospect is in the huge financial imbalances that characterise the US economy - imbalances that the 2000-2002 slowdown has done little to alleviate.

This year the current account balance of payments deficit is expected to amount to almost $600 billion (€513 billion) or 5.5 per cent of GDP. The government budget deficit will be close to $400 billion and the US private sector will run a financial deficit of about $200 billion.

How precisely do these imbalances pose a threat to economic recovery? Well, take the budget deficit for example. It is expected to rise to $500 billion-plus (4.5 per cent of GDP) next year - that is on the basis of optimistic activity forecasts.

This kind of deficit cannot last. Government spending, at some stage, must be cut and/or taxes raised to eliminate it. At that point, fiscal policy will become a major drag on the economy.

On the other hand, the longer deficit-busting policies are deferred, the more likely it is that financial markets will start extracting a penalty from the government in the shape of higher bond yields. That too would act as a drag on the economy.

What about the current account balance of payments deficit? Well, economists' thinking has long since evolved beyond the point where a current account deficit was regarded as a problem per se. Nowadays, we take a more holistic view.

A current account deficit is simply the obverse of a capital account surplus and, as such, reflects the rate at which the rest of the world is acquiring (net) domestic assets. Accordingly, a large current account deficit may or may not be a problem.

In the 1990s, the US managed to run a large and growing current account deficit (although never as big as it is now) and, at the same time, experienced an appreciating currency because the appetite for US assets amongst investors in the rest of the world was so strong.

The position has since changed in two respects. Firstly, the deficit has got even bigger. Secondly, the asset mix has changed. In the 1990s, it was US corporate bonds and equities that the rest of the world bought; now it is government bonds.

In these circumstances, there is a great risk that the necessary investment by the rest of the world in the US will take place only if the dollar falls sharply - not to €1.20 or €1.25 but to something like €1.40 or €1.50.

So, on one hand, there is a significant risk that the US economic recovery will be derailed by financial imbalances. On the other hand, there is a significant risk that, if the recovery is sustained, it will be accompanied by another plunge in the dollar. The latter risk suggests that the assumption that a US recovery will stimulate economic activity in Europe may be misplaced.

Since faster growth in European markets is a conduit through which a US recovery might be expected to impact positively on the Irish economy, the assumption that a US recovery will stimulate economic activity in the State may also be misplaced.

Of course, the stimulation of European economic activity is not the only conduit through which a strong US recovery is supposed to impact on the State. Arguably more important is the flow of direct investment into the Republic from US firms.

Clearly, the US slowdown of 2000-2002 was associated with a very pronounced weakening of such inflows. There seems to be an assumption out there that a US recovery will provoke a symmetrical response, an automatic strengthening of such flows.

I think this is a naïve view. When and if US foreign direct investment in Europe picks up pace again, it is likely to be of a different character to that which the Republic benefited from in the 1990s. It is also likely to be more strongly attracted to the new EU member-states of eastern and central Europe, and less strongly attracted to Ireland because of our now higher cost base. More on this at a later date.

Jim O'Leary is currently lecturing in economics at NUI-Maynooth. He can be contacted at jim.oleary@may.ie