The US central bank has cut US interest rates by a quarter of a percentage point to 1%, the lowest level since 1958.
Policymakers at the Federal Reserve said there had been some improvements, but added "the economy, nonetheless, has yet to exhibit sustainable growth".
The decision, which was passed by 11 votes to one, makes the first cut to rates since a reduction of half a percentage point in November 2002.
"The committee judged that a slightly more expansive monetary policy would add further support for an economy which it expects to improve over time," said the Federal Open Market Committee.
The dissenting vote was by San Francisco Federal Reserve president Robert Parry, who had called for a cut of half a percentage point to 0.75%.
Until Wednesday, US interest rates had been held steady at 1.25%, a 42-year low. This followed 12 cuts to the rate since January 2001, when the US economy first began to falter after an unprecedented boom in the late 1990s.
US stocks reacted badly to the news and the Fed's guarded economic outlook. Both the Dow Jones industrial average and the Nasdaq tech index gave up gains from earlier in the day.
Mr Greenspan's committee still has worries about the economy
The Dow Jones fell about 1% to close at 9,011.53, while the Nasdaq shed 0.19% to 1,602.63.
The dollar, however, advanced, reversing previous losses, after relief that the Fed has opted for a smaller cut.
"This [cut] certainly wasn't as dramatic a move as it could have been, and at the margin it's positive for the dollar providing we see positive US growth numbers continuing to come through," said Tim Stewart, chief currency strategist with Morgan Stanley in New York.
Late on Wednesday, the euro was trading at $1.1539, well off its day's high of $1.1621.
The US economy has made a lacklustre recovery, despite expectations of a rebound after the end of the war in Iraq.
Unemployment has also been an issue, currently standing at 6.1%, a nine-year high.
In its statement on Wednesday, the Fed pointed to improvements in financial conditions, the labour markets and spending.
However, it perceives that the upside and downside risks to sustainable growth for the next few quarters are roughly equal.
Policymakers were also conscious of the risk of deflation, described by Fed chairman Alan Greenspan last month as "minor" but a risk which could have grave consequences.
Following Wednesday's cut, the Fed pointed to "the probability, though minor, of an unwelcome substantial fall in inflation".
Deflation is when prices of goods start to drop, rather than rise. It can be very damaging because it makes shoppers reluctant to spend if they think prices will continue to fall.
The Fed may have been swayed from making a bigger cut by data on Tuesday showing that consumer confidence has held steady since May.
The survey of 5,000 US households showed that optimism over a newly buoyant stock market was tempered by fears over business confidence and the job market.
A strong US housing market has also provided some cheer for economists. New data has shown that sales of new single-family homes jumped more than 12% last month.
There were fears that a cut of half a percentage point would have suggested an end to any further rate-cutting in the near future, which in turn would have signalled a rise in long-term interest rates.
Economist Anthony Chan of Banc One Investment Advisors said policymakers were preserving firepower in case the economy needed more stimulus.
"There is little doubt that when an individual is besieged by many attackers while holding limited ammunition, each shot is used sparingly," said Mr Chan.