WASHINGTON — Bold action by Federal Reserve Chairman Ben Bernanke averted a Black Tuesday on Wall Street, reversing a global stock sell-off by announcing the largest single-day rate cut in the Fed's modern history.
The Fed's surprise move to lower its benchmark lending rate by three-quarters of a percentage point to 3.5 percent was followed immediately by commercial banks, which took down the prime rate they charge their best customers to 6.5 percent.
Over time, the rate cuts should lower borrowing costs for consumers and businesses alike, sparking economic activity. The cost of revolving credit card debt for millions of Americans should fall, since the variable lending rates on these cards are tied to the prime rate. Some homeowners with adjustable-rate mortgages also may benefit.
But the rate reductions do little for what ails the U.S. economy: a housing sector in a deep funk and credit markets in turmoil because of uncertainty over who holds how much exposure to complex financial instruments.
Instead, the rate cuts targeted investor confidence and thus provided a psychological shot in the arm, at home and abroad.
"Both with the inter-meeting nature and the size, it is saying, `Your Federal Reserve is on the job,' " said Alice Rivlin, a former Fed vice chairman and Fed governor from 1996 to 1999. She added that the action seeks to address "a mass psychology phenomenon."
The rate reductions halted what began as a 460-point plunge of the Dow Jones Industrial Average soon after trading opened Tuesday. The Dow finished the day down a modest 128.11 points. The S&P 500 closed down 14.69 points at 1310.50, while the tech-heavy NASDAQ was off 47.75 points to 2292.27.
The Fed action also put wind in the sails of overseas exchanges.
Sliding stocks in Europe turned positive, and in Brazil, one of the important developing nations and an engine of global growth, the Bovespa rose 4.45 percent Tuesday after falling 6.6 percent the day before. This raised hopes that big developing countries, and thus the global economy, can withstand a U.S. downturn.
"Brazil and other emerging economies are in much better shape now to deal with this crisis than in the past," said Marcelo Moura, an economist at the Sao Paulo-based business school Ibmec. "The fundamentals here are still strong."
Next door in Mexico, a nation joined at the hip to the U.S. economy, the Bolsa had fallen 5.3 percent Monday, but it gained almost 6.4 percent Tuesday.
The Fed's action was the first cut between meetings since Sept. 17, 2001, the week after the 9-11 terrorist attacks, and the steepest since the Fed began issuing statements in 1994. Before Tuesday's action, the Fed had lowered rates between meetings only four times: three times in 2001 and once in October 1998 amid a currency crisis in Asia and Russia.
In its statement, the Fed signaled that it was open to more cuts.
"Appreciable downside risks to growth remain. 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 risks," the Fed said.
Although Bernanke had signaled deep rate reductions, his hand was forced by the huge percentage declines in European and Asian stock markets Monday, while U.S. markets were closed for the Martin Luther King Jr. holiday.
Now, many experts question how much dry powder he has left to respond to further challenges.
"I think the risk of appearing to be responsive to market events is that you get evaluated in terms of what the market does, and that does confuse people in regards to your intention for the economy," said Vincent Reinhart, a former Fed director who's now a scholar at the American Enterprise Institute, a conservative policy-research group.
Wall Street is betting on rate cuts again next week and beyond amid continuing problems in the housing sector and credit markets. But some economic challenges only loom larger with rate reductions.
One is the dollar's weakening against world currencies. This has helped U.S. exports grow sharply and has offset the economic growth that's been lost to the protracted housing slump. But Tuesday's steep rate cuts may weaken the dollar further, and that could sharply raise the prices of imported products that U.S. consumers buy from across the globe. This rise in prices across the economy is inflation.
"Right now, they've (the Fed) shifted focus to the economic expansion because that's what is at risk. But going forward, they're going to have to be worried about inflation too," Reinhart said. Consumer inflation was 4.1 percent last year, the highest rate since 1990.
Laurence Meyer, a Fed governor from 1996 to 2002, shares that view.
"There is a very complicated picture," he said, citing inflation pressures and concerns that large federal deficits limit the size of the $140 billion economic stimulus that President Bush and Congress are negotiating. "There is a limit to what you can do given budget realities."
Bush went before the cameras Tuesday, flanked by congressional leaders, to talk up the economy.
"All of us understand that we need to work together; all of us understand that we need to do something that will be effective; and all of us understand that now is the time to work together to get a package done," the president said after the meeting.
Senate Majority Leader Harry Reid, D-Nev., said the "downturn in the global markets demonstrates how urgently we need to act to revive our nation's faltering economy." He suggested that a stimulus plan could be approved within three weeks.
Everyday Americans have a large stake in Wall Street's recent volatility.
Millions of them depend on the stock market, through their 401(k) plans, for their retirement income. A falling stock market amounts to declining personal wealth, in the short run at least, and comes on top of decreasing home prices and the bite of rising inflation and sky-high energy prices. This is why Democratic and Republican presidential candidates are rushing out economic proposals.
Tuesday's rate cut offered no panacea to the troubled housing sector. Home builders must sell off their vast oversupplies of new homes before they can see a rebound. And mortgage rates are influenced not by Fed rates but by yields on long-term bonds, which take their cues from the economy and inflation, neither of which look good right now.
(David Lightman, Renee Schoof and Tony Pugh in Washington and Jack Chang in Brazil contributed to this article.)