The move was expected to add further momentum to a dramatic plunge in other interest rates.
It was the second time in six weeks the Fed has cut its discount rate, the interest it charges to make loans to financial institutions. A cut in the discount rate is the most dramatic signal the central bank can send that it intends to push interest rates lower.
Interest rates have already fallen sharply this year, reacting both to an easier monetary policy on the part of the Fed and to the dramatic plunge in world oil prices.
Wide anticipation of the latest cut helped spur huge rallies Wednesday in the stock and bond markets.
The Fed's move, which will take effect on Monday, puts the discount rate at its lowest level since early 1978. A wide variety of other interest rates, including mortgage rates, are also at their lowest levels in eight years and economists predicted that the new discount rate cut, down from 7 percent, will send rates lower still.
The Fed decision was made on a 4-1 vote with Fed Reserve Chairman Paul Volcker voting with the majority.
In announcing the decision, the Fed said a cut in the discount rate ""appears consistent with international interest rate considerations.''
Japanese newspapers reported earlier that the Bank of Japan likely would cut its discount rate Saturday if the U.S. Federal Reserve Board trimmed its comparable rate Friday.
Quoting sources, the Japanese news reports said that if the U.S. discount rate was cut, the central bank would most probably convene a special meeting of its policy board on Saturday and implement a half percentage point reduction from its current rate of 4 percent. …