The surprise reduction in the federal funds rate from 4.25 down to 3.5 percent marked the biggest funds rate cut on records going back to 1990.

Federal Reserve Chairman Ben Bernanke and his colleagues took the action after an emergency video conference on Monday night, a day when global markets had been pounded by rising concerns that weakness in the world's largest economy was spreading worldwide.

In a brief statement explaining its move, the Fed said that "appreciable downside risks to growth remain" and officials pledged to "act in a timely manner" to deal with the risks facing the economy. The action was approved on an 8-1 vote.

Analysts said the fact that the Fed did not wait until its meeting next week to cut rates underscored the seriousness of the situation.

"The world's stock markets are in meltdown so the Fed came in with an inter-meeting move to try to stop the panic," Christopher Rupkey, senior economist at Bank of Tokyo-Mitsubishi.

The Bush administration, which had announced on Friday that President Bush supported a $150 billion economic stimulus package, said Tuesday that it was not ruling out doing more than the $150 billion proposal if necessary.

Many analysts said if the carnage continues in stock markets, the Fed will move to cut rates again at its Jan. 29-30 meeting.

"This move is not an instant fix," said Ian Shepherdson, chief U.S. economist at High Frequency Economics. "The economy is still staring recession in the face, but at least the Fed now gets it."

In addition to cutting the funds rate, the Fed said it was reducing its discount rate, the interest it charges to make direct loans to banks, by a similar three-quarters of a percentage point, pushing this rate down to 4 percent.

Commercial banks responded to the Fed's action on the funds rate by announcing similar cuts of three-quarter of a percent on its prime lending rate, the benchmark for millions of business and consumer loans. The action will mean the prime lending rate will drop from 7.25 percent down to 6.50 percent.

The Fed action was the most dramatic signal it can send that it is concerned about a potential recession in the United States.

The Fed action occurred after global financial markets had plunged Monday as investors grew more concerned about the possibility that the United States, the world's largest economy, could be headed into a recession. Many markets suffered their biggest declines since the September 2001 terrorist attacks.

In its statement, the Fed said it had decided to cut the federal funds rate "in view of a weakening of the economic outlook and increasing downside risks to growth."

The central bank said that the strains in short-term credit markets have eased a bit, but "broader financial market conditions have continued to deteriorate and credit has tightened further for some businesses and households. Moreover, incoming information indicates a deepening of the housing contraction as well as some softening in labor markets."

The move caught financial markets by surprise. Many had expected the central bank would wait until its meeting next week to make any move in interest rates. The Fed made the move before markets had opened in the United States.

Before Tuesday's move, the Fed had cut interest rates three times, beginning in September, the month after a severe credit crunch had roiled Wall Street and global financial markets. The Fed cut the funds rate by a half-point in September and then by smaller quarter-point moves in October and December.

"The committee will continue to assess the effects of financial and other developments on economic prospects and will act in a timely manner as needed to address those risk," the Fed statement said.