Economics: I watched Questions and Answers on RTÉ last Monday night. Inevitably, in the aftermath of the recent Forfás report, the subject of inflation came up, writes Jim O'Leary.

As the discussion started, I predicted to my wife that the behaviour of the exchange rate, the single most important determinant of inflation in a small open economy like Ireland, would not rate a mention. I was almost right. No one bar Willie O'Dea even referred to the exchange rate, and no one at all ascribed to it any role in the acceleration of Ireland's inflation rate and the concomitant hike in the price level that have occurred over the past five years.

Why the silence? Is it perhaps that people feel that, because we no longer have our own separate currency, the concept of an exchange rate has become superfluous and should be removed from the lexicon? (Incidentally, this seems to be the view at the Central Bank. What, pre-euro, it used to call the Effective Exchange Rate Index, a trade-weighted measure of the currency's value, is now called the Trade Weighted Competitiveness Index.)

Perhaps a more valid explanation is that people don't fully realise how important a variable the exchange rate is in the Irish economy. Typically, when the contribution of a falling exchange rate to inflation is being considered, for example, the thoughts of many commentators go no further than its direct impact on import prices.

And, if this was as far as the influence of currency movements went, then it would be fair to conclude that the 20 per cent fall in the value of Ireland's currency between 1996 and 2001 had only a modest effect on inflation, because over this period import prices were surprisingly restrained. Certainly, they never increased at anything like the 10 per cent-plus rate recorded by many categories of sheltered services in the latter part of that period.

But of course the influence of a depreciating currency extends much further than import prices, especially in a very open economy. It boosts competitiveness and thereby boosts aggregate demand, and the closer the economy is to its capacity constraints, the more that boost to aggregate demand gets translated into upward pressure on prices generally, especially the price of labour.

Ultimately, it gets translated into upward pressure on the prices of those sheltered services that have no apparent connection with the exchange rate.

So, at least some (and possibly a good deal) of the blame for the rampant inflation that has recently occurred in the services sector in Ireland can be laid at the door of exchange rate movements up to mid-2001.

Now that the exchange rate has turned around - indeed, more than three-quarters of the fall that occurred between 1996 and mid-2001 has been clawed back at this stage, much of it over the past six months - the process described above has gone into reverse, albeit with a time lag. Import prices are now falling, as are the prices of internationally traded goods and services generally (for example, manufactured export prices fell by almost 10 per cent in the 12 months to March). This is exerting downward pressure on the inflation rate as measured by the CPI, although that benign influence is being obscured by the effects of Government-inspired price increases in the form of indirect tax hikes and rising public sector charges.

But in a sense what is visible in the form of falling import prices and the like represents just the tip of the iceberg.

Below the visibility threshold of the CPI, the huge currency-turnaround of the last year or so is exerting enormous deflationary (and disinflationary) power through its dampening effect on aggregate demand.

As I argued in my last article, the toll that this will exact by way of reduced output and employment will depend on how quickly the economy's cost structure adjusts to the new reality.

The slower that adjustment, the bigger the job and output losses.

Unfortunately, the signs are that we are a nation of slow adjusters. Among the most eloquent of the signs: the wage increases agreed under the latest partnership agreement. With the passing of every day, these wage increases look more and more like an economic suicide note for the exposed sectors.

By the same token, the much-trumpeted package of anti-inflation measures set out in Sustaining Progress, more and more call to mind the story of the Japanese soldier found on a remote Pacific island, ignorant of the fact that the second World War had ended four decade earlier.

Inflation is yesterday's problem: it is not beyond the realms of possibility that it will have fallen to around 1 per cent by the end of next year. If so, it will have little to do with the social partners' efforts although, as I've said before, that won't stop them claiming the credit.

Of course, there should be no surprise at the redundancy of the anti-inflation campaign. Our social partners have displayed a canny sense of timing on several other issues in recent times. After all, these are the same people who have (i) launched a major initiative to boost the output of affordable housing just as the housing market is displaying clear signs of over-supply, and (ii) sanctioned an average 9 per cent increase in public sector pay rates, designed inter alia to overcome recruitment and retention problems, at a time when public sector employment is increasing rapidly (and private sector employment is stagnating).

As Wednesday's OECD survey stated, the Celtic Tiger era is over. The policy challenge now is to ensure that the period that follows does not become known as the Celtic Dinosaur era. Perhaps we might start by changing some of the zookeepers, or at least enrolling them on an intensive re-education programme (with no tuition fees, naturally).

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