As expected, the Fed's policy-making committee issued a brief statement that it left the federal funds rate, the interest that banks charge one other, at 6.5 percent.
In its statement, the Fed noted that the economy could grow at a sustainable pace that does not spark inflation. However, the Fed said it remains biased toward raising rates in the future if necessary, warning that "the risks continue to be weighted mainly toward conditions that may generate heightened inflation pressures in the foreseeable future."
The Fed also noted that the tight labor market and high energy prices have not significantly raised prices so far, but the factors still pose a risk of "raising inflation expectations."
Since June 1999, the Fed has raised rates six times for a total increase of 1.75 percentage points. The last rate movement was an aggressive half-point increase on May 16; the Fed has decided to leave rates alone during its past four meetings.
Wednesday's inaction didn't surprise economists and investors, as several recent economic reports have indicated the economy is slowing, and inflation remains tame.
At the time of the Federal Reserve's announcement, the Dow Jones industrial average was up about 100 points. The index of 30 stocks has remained almost unchanged since the last Fed meeting on Oct. 3.
The Nasdaq composite index, which has fallen about 7 percent since the October meeting, was up 43 points .
However, as soon as word reached investors that the Fed was retaining a bias in favor of raising rates--rather than lowering its stance to neutral--stocks began to slide. The Dow closed at 10,707.60, up 26.54, and the Nasdaq closed at 3165.49, up 27.22.
The Federal Reserve's primary mission is to keep inflation under control, and its main weapon is interest rates. When the Fed, which is chaired by Alan Greenspan, senses that the economy is growing at a rate that could ignite inflation, it often raises rates.
Rising interest rates make it more costly for businesses to finance expansion plans, putting the brakes on economic growth. Rising rates often result in falling stock prices, however, as corporate earnings are crimped and interest-paying investments become more attractive.
The Federal Reserve's policy-making committee meets again Dec. 19. Many Wall Street analysts hope it will change to a so-called neutral bias if the economy continues to show signs of a slowdown, followed by a cut in rates sometime next year.