The rate cut put the central bank's federal funds rate at 1%. That matched the lowest level for this overnight bank lending rate ever -- the last time it was at 1% was from June 2003 to June 2004.
Investors had been expecting a half-point cut and some were betting that the Fed would even cut rates by three-quarters of a point to 0.75%.
The Dow Jones industrial average, which had been higher ahead of the Fed's decision, turned lower shortly after the announcement.
The fed funds rate is used to set rates for a wide variety of consumer loans, including home equity lines and credit cards, as well as for many business loans. The lower the rate, the more the Fed hopes to spur economic activity.
The Fed said in a statement that it was concerned about the drop-off in consumer and business spending due disruptions in the credit markets and warned that the economic slowdown is likely to get worse.
"The intensification of financial market turmoil is likely to exert additional restraint on spending, partly by further reducing the ability of households and businesses to obtain credit," the central bank said in its statement.
This is the ninth time that the central bank has lowered rates since September 2007 in an effort to deal with the problems in the U.S. economy and credit markets. The Fed also lowered its discount rate by a half-percentage point to 1.25%. That is the rate at which it lends directly to banks and Wall Street firms.
The Fed's last cut was an emergency half-point reduction on Oct. 8. Six other central banks around the globe also lowered rates that day in a coordinated move. The European Central Bank and the Bank of England are scheduled to meet next on Nov. 6.
While rate cuts are traditionally the key tool the Fed uses to stimulate the U.S. economy, it has had to take other steps to address the current credit crisis.
The Fed has loaned hundreds of billions of dollars to banks through a new lending facility and is starting to loan money directly to major businesses by purchasing commercial paper, which is what some banks and businesses use as their primary method to fund day to day operations.
In its statement, the Fed also appeared to concede that these actions would not lead to an immediate return of economic growth. The Fed projected improved credit markets and a return of moderate growth "over time." And it warned that "downside risks to growth remain."