There are two pivotal and, for the moment, unanswerable questions about the stock market's latest nervousness: (1) Will stocks continue to decline? and (2) How would that affect consumer and business spending? The ultimate answers will have huge social and political repercussions, because we live in what economist David Wyss rightly calls a "Tinker Bell economy--if you think you can, you can." Everything depends on confidence, and the market is critical to confidence.

A soaring market has emboldened consumers to spend and companies to invest. A sinking market could do the reverse--with wide ripple effects. Governments at all levels, for example, have reaped immense increases in tax revenues. Donald Boyd of the Center for the Study of the States in Albany, N.Y., reports this paradox: Although 31 states cut income taxes in 1998, state tax revenues--as a share of personal income--remain near record levels. The apparent explanation lies in the extra taxes generated by capital gains (profits on stocks), stock options and corporate bonuses.

The history of recent market drops ought to reassure. Last summer, the market fell about 20 percent after Russia defaulted on loans. It recovered without savaging consumer confidence or sabotaging the economy. There's a plausible logic now for the same outcome. Consider so-called "market capitalization." This is the value of all stocks traded on U.S. markets. On July 16 market capitalization hit a historic high of $14.5 trillion, according to Wilshire Associates. Since then (through Oct. 18), it's dropped about 11 percent to about $12.9 trillion.

This $1.6 trillion paper loss is a lot of money. But the market's surge has been so huge that capitalization remains higher than at year-end 1998 ($12.6 trillion) or year-end 1997 ($10.3 trillion). Perhaps half of U.S. adults now own stocks. As gains or losses enrich or impoverish, people raise or lower their spending. Economists who evaluate this "wealth effect" don't yet predict a recession.

Joel Prakken of Macroeconomic Advisers estimates that every dollar's worth of stock gain causes people to raise their spending by 2 cents after one year and 4 cents after three years. This means that a $1 trillion jump in stock values results in a first-year spending increase of $20 billion (2 percent of $1 trillion). Stock losses cause identical spending cutbacks. Because Prakken thinks the market has been "overvalued," his forecast assumes a drop of 13 percent. Still, there's no recession in 2000. The economy merely slows. It remains resilient because previous stock gains raise spending more than recent losses reduce it.

If nothing else happened, the recent market drop might be a good thing. It could dampen inflationary pressures. The danger is that stocks could fall further. Suppose market psychology shifts from greed to fear. This could produce a selling avalanche or a buyers' strike. Either could depress prices dramatically. Moreover, there are features of the present market that could aggravate any shift in psychology:

* Stock Options: There's an overhang, as companies--especially technology companies--have issued them in record numbers. In 1998 options equaled about 6.6 percent of outstanding shares, reports Pearl Meyer & Partners, a consulting firm. That's double the 1989 level. A falling market could cause option holders to exercise their options and sell. (An option involves the right to buy stock at a fixed price. If the market price is higher, the stock can be sold for a profit. But if the market price drops below the option price, the option is worthless.)

* Retirement Accounts: At year-end 1998 they accounted for about 40 percent of the $3 trillion of stock mutual funds. Worried about protecting paper profits, investors could shift money into bond funds or money-market funds without paying capital gains taxes. That would prompt huge sales. Likewise, investors could steer new contributions away from stocks.

* Foreign Investors: In 1998 they bought $43 billion of U.S. stocks--about seven times their average annual purchases in the 1980s. But a lower stock market and a falling dollar on foreign exchange markets could depress buying or inspire selling. (A falling dollar means foreigners suffer losses when converting dollars back into their currencies.)

Perhaps the largest mystery is major corporations. Unrecognized by the public, they've been big buyers of their own stock. In 1998 companies in the Standard & Poor's 500 Index spent $144 billion to buy their shares--a 120 percent rise from 1995. About half the purchases provided stock for options; the rest reduced shares and boosted per share profits. But the cost is steep. A staff study by the Federal Reserve of 144 companies found that dividends, share repurchases and new investment amounted to almost 125 percent of after-tax profits in 1998. Companies borrowed to fill the gap. The Fed study suggested that this cannot continue indefinitely and that if stock repurchases shrink, prices might drop 32 percent to 38 percent.

Hmm. Federal Reserve Chairman Alan Greenspan warns that markets sometimes panic. Prices don't just decline. They plunge. Economist Wyss of Standard & Poor's DRI isn't predicting a recession. But he admits that a 30 percent drop in stock prices could cause one by early 2000. There are other unfavorable signs. In 1998 the Fed cut interest rates after Russia's default; now fear of inflation has prompted the Fed to raise rates.

If the economy sours, a political fallout might follow. The boom has pushed popular expectations to lofty, probably unrealistic, heights. A poll by CBS.Marketwatch.com finds that 47 percent of respondents think the market will rise in the next year; only 31 percent expect a drop.

People hold incumbents responsible for the economy. In many ways this is unfair. But politicians encourage it by self-congratulation for any success. President Clinton has embraced this tradition. His policies didn't make the boom, nor will they break it. But he's claimed credit, and if it falters, he--and the Democratic presidential nominee--may bear the blame.