A sudden sharp jump in European interest rates - triggered by a rise in oil prices, for example - could knock as much as three percentage points off economic growth, according to the ESRI.

Although the Economic and Social Research Institute is optimistic about performance in the years ahead, it notes that the economy remains vulnerable to shocks such as a sudden rise in interest rates or a collapse in the US stock market.

A number of areas of concern - such as excessive wage demands, the pressure on infrastructure and the housing market - add to vulnerability, the ESRI says.

"The dangers arising from the potential bubble in the housing market are significant," the report says. "While this potential bubble is unlikely to burst on its own, it could turn an external shock to the Irish economy into a cause of major trauma."

Such economic shocks could take a number of forms. The ESRI notes that the Irish economy has become steadily more vulnerable to interest rate shocks over the last 15 years, with the private sector's exposure now of crucial importance.

A sudden 2 per cent rise in interest rates could reduce the growth rate to between 1.5 per cent to 2.5 per cent a year, which the ESRI describes as a recession on a par with the early 1990s.

Provided such a shock was not accompanied by additional aggravating factors the downturn should be only temporary, with output and employment returning to projected levels after three or four years.

"However, the short-term effects could be quite unpleasant, especially for those who suffered unemployment or who were overexposed in the housing market," the ESRI says.

The report considers the impact of a 25 per cent drop in the value of US equities on the Irish economy, particularly in light of Ireland's rising dependence on the US high-tech manufacturing sector.

Again, the shock would be expected to trigger a downturn in house prices and a fall in personal consumption, pushing the Gross National Product (GNP) 3 per cent below forecast.

Another potential shock could be caused if one or two members of the euro zone experience fiscal problems, causing the break-up of Economic and Monetary Union or a permanent rise in oil prices.

But the economy is not just vulnerable to external shocks. The ESRI says there are a range of domestic factors which could cause it to perform in worse than expected fashion.

These include failure to deliver the increase in infrastructure necessary for rapid growth; excessive wage rises which impact adversely on long-term competitiveness; and inappropriate fiscal policy.

If wage rates in the public and private sector were to increase more rapidly than forecast and infrastructure bottlenecks - especially in areas such as transport and housing - were to add to production costs, growth could fall by 1.5 per cent per annum, the institute says.

On the other side of the equation, there are also risks involved in the economy growing more rapidly than expected. Factors which could lead to higher-than-expected growth include a rapid rise in productivity as a result of the increasing human capital of the workforce and continuing high net immigration, as Irish citizens return and foreigners arrive to fill the gaps in the domestic labour market.

While higher growth would result in higher government revenue, it would also put huge additional pressure on domestic infrastructure and require very substantial public investment as well as adding to pressure on the environment.

The need for additional housing would only be one aspect of the pressure - sanitary services to allow such homes to be built, urban infrastructure and public transport would all require additional investment, the review says.

"Without this additional investment, the direct and indirect cost of living and working in Ireland would almost certainly choke off the potential for higher growth."

This further emphasises the need for investment in infrastructure if the economy is to achieve its potential growth rate over the next decade, the ESRI says. "There is a greater danger from under-investing than from over-investing," it notes.

In terms of the ability of policy-makers to cope with unexpected economic shocks, fiscal policy will be a key factor, as monetary policy is now set by the European Central Bank in Frankfurt, taking the needs of the euro-zone as a whole into account.

If future governments are to have adequate scope for undertaking a counter-cyclical fiscal policy to cushion the economy from adverse shocks, a substantial Exchequer surplus should be recorded when the economy is at trend growth, the review says.

"Even with a surplus of 1.5 percentage points of GNP at trend growth, the public finances could be pushed into deficit in the face of a serious external shock," the ESRI says. "Given that the economy is currently running significantly above trend, this argues for a surplus, under these conditions, of significantly more than two percentage points of GNP."

It notes that the cost of too tight a fiscal policy would be small but the cost of too lax a policy could be high in the face of external shocks.