"Even before the tragic events of last week, employment, production and business spending remained weak, and last week's events have the potential to damp spending further," the board of governors said in a news release. "Nonetheless, the long-term prospects for productivity growth and the economy remain favorable and should become evident once the unusual forces restraining demand abate."
The move had been widely anticipated. Stocks are expected to open sharply lower Monday, almost a week after the terrorist attack on the World Trade Center and the Pentagon. European markets have fallen about 10 percent since the attack. Lower interest rates generally boost spending.
The federal funds rate has now been lowered from 3.5 percent to 3 percent, and the discount rate was trimmed from 3 percent to 2.5 percent.
Stocks in Europe jumped, gaining 1 percent to stand about 0.75 percent higher for the day, standing in contrast to earlier losses of more than 2.5 percent.
"I think it is an encouraging development," said Gary Thayer, chief economist at A.G. Edwards in St. Louis.
"The Fed is responding to financial developments and it goes along with their commitment last week to provide liquidity. This could help ease the opening of the market today."
It is the third time the Fed has lowered rates in between meetings this year. Interest rates are now at their lowest levels in seven years.
The board of governors is scheduled to meet again Oct. 2.
The Fed is not alone in taking steps to help the markets recover from the attack. The Securities and Exchange Commission announced several rule changes last week designed to help get the stock markets up and running smoothly Monday.
Publicly traded companies will be allowed to repurchase shares without meeting the usual volume and timing restrictions, and without adverse accounting consequences.
Several companies have already taken advantage of that relaxing move; Altera, Cisco Systems, E*Trade, Intel, Paradyne and Sanmina have all announced new or expanded buyback programs.
Reuters contributed to this report.