The central bank also reduced its discount rate, the interest it charges in making direct loans to banks, by a half-point as well. The Fed already had cut the discount rate on Aug. 17 as it scrambled to respond to the growing credit crisis.

Stocks immediately rallied on the moves, which were more aggressive than many investors had expected.

The action was designed to boost economic growth by lowering borrowing costs for millions of consumers and businesses. Commercial banks were expected to quickly match the Fed's action by cutting their prime lending rate. The prime rate has been at 8.25 percent for the past 15 months.

The Fed's action came in the midst of the worst slump in housing in 16 years. That downturn has triggered record defaults in subprime mortgages and roiled financial markets around the globe as investors have become worried about where the spreading credit problems will next appear.

The financial market turmoil represents the first major test for Fed Chairman Ben Bernanke, who took over from the venerable Alan Greenspan in February 2006.

Tightening Credit

In explaining its action Tuesday, the Fed said that "the tightening of credit conditions has the potential to intensify the housing correction and to restrain economic growth more generally."