The decision follows a bolder move in September when it lowered rates from 5.25% to 4.75% - the first US rate cut in four years.
Why did the Fed cut rates, and why does it matter for the rest of the world?
What has the US central bank done?
The US central bank has trimmed interest rates for the second month in a row, a reversal in its two-year policy of raising rates to combat inflation.
But it cut rates by 25 basis points, less than the amount after its September meeting.
The move shows how seriously the Fed takes the turmoil in the world's financial markets which has threatened to derail the US and world economy.
Why does the Fed decision matter?
Many experts believe that only a substantial cut in interest rates by the Fed would have been enough to calm the turbulence in the world's financial markets.
The decision sends a strong signal that the US authorities are prepared to intervene to stabilise the markets and to prevent the US economy sliding into recession.
And it will reassure banks and governments around the world that the US was prepared to take a lead in tackling the current crisis.
How does a rate cut help?
By cutting rates, the Fed is boosting the US economy by making it cheaper to borrow money.
It is also taking the pressure off companies and banks who are suffering a credit crunch: they find it difficult to borrow money to finance their normal operations due to fears of looming bad debts in the system.
And it might help stabilise the US housing market, which is tumbling as a result of the sub-prime scandal, where too much lending was made to individuals that were not credit-worthy.
Many of these households are now in default, and with banks beginning to repossess their homes a glut of unsold homes is depressing the property market.
Why does it matter to the rest of us?
The US is the world's largest economy, so a slowdown in growth there could affect the prospects for the economy in Europe and Asia.
And the fears about bad credit risks in financial markets have already spread to the banking sector in Europe and the UK.
The Fed move also signals that interest rates are likely to be cut across the world, at least in the short-term, to prevent the crisis getting worse.
Will it work?
It is not certain that even two rate cuts will be enough to either calm the markets or avoid an economic downturn in the longer term.
In particular, the US housing market is now so fragile that even lower rates may not persuade people to buy houses right now - and a big slowdown in housing and construction is already having a knock-on effect on the economy.
And until the banking system reveals the full extent of its potential losses from bad debts, there will still be the potential for further panics.
And that makes it more likely that other central banks, like the Bank of England, may have to cut rates sooner rather than later in order to reduce the risk that the crisis will continue.
