The federal funds rate was lowered 50 basis points to 4 percent, a seven-year low.
In its statement, the Fed said it remains concerned about the sagging U.S. economy, adding that it sees conditions that indicate further deterioration.
Soon after the announcement of the rate cut, which was widely expected on Wall Street, the Dow Jones industrial average and the Nasdaq posted modest gains.
"The market got all that it could have possibly wanted," said Todd Clark, co-head of trading at WR Hambrecht.
Clark said investors were concerned that the Fed would cut rates and shift to a neutral bias, which would mean it viewed the outlook as evenly balanced between growth and economic weakness. Such a change would signal that the Fed may not cut rates further.
In noting that the economy remains at risk, the Fed left the door open for additional cuts, Clark said. That's positive news for Wall Street because rate cuts can spur economic activity.
In its announcement, the Fed included a short list of economic signs that seem troubling, such as lower spending on capital equipment, earnings warnings, an uncertain business outlook, and a decline in consumer wealth caused by the sharp decline in the stock markets.
"The erosion in current and prospective profitability, in combination with considerable uncertainty about the business outlook, seems likely to hold down capital spending going forward," the Fed said. "This potential restraint, together with the possible effects of earlier reductions in equity wealth on consumption and the risk of slower growth abroad, continues to weigh on the economy."
On the positive side, the Fed noted that companies' high inventory levels have lessened somewhat, and consumer spending has remained strong.
In 1999 and 2000, the Fed raised the funds rate six times for a total increase of 1.75 percentage points to a high of 6.5 percent in May. It also hiked the discount rate five times to 6 percent, an increase of 1.5 percent.
However, recent economic data have indicated that the U.S. economy might be slowing too much, so the Fed started its assault Jan. 3 and has lowered rates by a half-point each time.
The Federal Reserve's primary mission is to keep inflation under control, and its main instrument is interest rates. When the Fed senses the economy is growing at a rate that could ignite inflation, it often raises rates, which raises the cost of borrowing money and pinches corporate activity.
But when the economy seems headed for trouble, the Fed decreases rates. Lowering interest rates make it less costly for businesses to finance expansion plans, sparking economic growth. Lower rates can result in stabilizing stock prices too, because interest-paying investments become less attractive.
The Federal Reserve's policy-making committee meets again June 26-27.