The federal funds rate was lowered 50 basis points to 2 percent, a level not seen since the early 1960s. The funds rate is the interest that banks can charge each other for overnight loans.
The Fed also lowered the discount rate, the interest rate it charges banks to borrow, by 50 basis points to 1.5 percent.
"Heightened uncertainty and concerns about a deterioration in business conditions both here and abroad are damping economic activity," the Fed said in its statement.
It added, however, that even though investment in more security after the Sept. 11 terrorist attacks may curtail economic productivity, the "long-term prospects for productivity growth and the economy remain favorable and should become evident once the unusual forces restraining demand abate."
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 raised the discount rate five times, to 6 percent, an increase of 1.5 percentage points.
However, recent economic data have indicated that the U.S. economy might be slowing too much. The Gross Domestic Product (GDP), the value of all U.S. goods and services, grew 1.9 percent in the fourth quarter of 2000, 1.3 percent in the first quarter of 2001, and a timid 0.3 percent in the second quarter. Preliminary data for third-quarter GDP showed that economic growth fell by 0.4 percent.
Fed Chairman Alan Greenspan and other Fed members started the assault on interest rates Jan. 3 by cutting rates after an unscheduled meeting. They have lowered rates after each meeting this year.
The Fed took a pro-active stance after the terrorist attacks on Sept. 11, making an unscheduled interest rate cut Sept. 17 in an effort to calm the financial markets and stave off negative effects on the economy.
Even though the markets reopened the following week to post huge losses, the major U.S. markets have climbed back from post-Sept. 11 lows.
The Fed's primary focus is to contain inflation, and its main instrument is interest rates. When it senses the economy is growing at a rate that could ignite inflation, it often raises rates, which increases the cost of borrowing money and can pinch corporate financial activity.
But when the economy seems headed for trouble, the Fed lowers rates. Lowering interest rates makes it less costly for businesses to finance expansion plans and increases the incentive to borrow money, which can spark economic growth. Lower rates can result in more stable stock prices, too, because interest-paying investments become less attractive.
Economists generally believe that the positive effects of interest rate cuts take several months to appear, and even then, some industries might benefit more than others. Some industry analysts say they believe that cheaper loans might not immediately help technology companies, because the industry faces other issues like excess inventory and decreased customer equipment spending.
The Fed's policy-making committee meets again Dec. 11.