Today's action is intended to help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets and to promote moderate growth over time," the Fed said in a statement outlining its decision.
The central bank said that it still believed the economy faced some risk of inflation, but said that financial market developments since its last meeting in early August had increased the uncertainty surrounding the economic outlook.
"The committee will continue to assess the effects of these and other developments on economic prospects and will act as needed to foster price stability and sustainable economic growth," it said.
The decision comes as evidence accumulates that a prolonged U.S. housing market downturn and a wild financial market ride over the summer has taken a toll on broader economic activity.
A decline in employment in August, the first drop in four years, appeared to confirm that housing-related strains were weighing on businesses and impacting households.
In addition, reports on retail sales and industrial output in August also showed some softness.
Change in August
At its last regularly scheduled meeting on August 7, the U.S. central bank had said its predominant concern was inflation, even as it noted tighter credit and financial market volatility.
Within days of the Fed's August 7 meeting, financial markets unraveled as French bank BNP Paribas froze three funds with U.S. subprime mortgage market exposure. The Fed on August 10 said it would pump cash into the banking system as necessary to keep markets functioning normally.
Even so, stock markets tumbled the following week, at one point plumbing declines of more than 10 percent below 52-week highs before rebounding.
The U.S. central bank then stepped in on August 17 with a surprise cut to the discount rate and an explicit acknowledgment that risks to growth had "increased appreciably."
Further seeking to sooth markets, Fed Chairman Ben Bernanke addressed the turmoil directly in a speech on August 31. His comments that the Fed stood ready not only to provide liquidity but to limit adverse impacts to the economy seemed to seal the prospect of a cut to the more-important federal funds rate.