The Federal Reserve lowered its benchmark interest rate by a quarter point to 4.25 percent, while signaling officials are open to further cuts if the housing slump and credit squeeze worsen.

Stocks fell and Treasury notes surged after the decision, which some economists said fell short of what's needed to spur lending and avert a recession. The central bank also pared the discount rate by a quarter point to 4.75 percent, counter to speculation among investors that the Fed would make a deeper reduction.

"Recent developments, including the deterioration in financial market conditions, have increased the uncertainty surrounding the outlook for economic growth and inflation," the Federal Open Market Committee said in a statement. Lower borrowing costs "should help promote moderate growth over time."

The Fed dropped language from its previous statement that risks of slower growth and faster inflation were "roughly" balanced. The economy is faltering after a third-quarter surge as house prices drop, consumer spending slows and banks tighten lending standards for even their best customers.

Policymakers are actively considering steps to ease credit in financial markets and haven't ruled out moves to increase liquidity before their next scheduled meeting on Jan. 29-30.

"If things deteriorate, they will cut again," said Stephen Cecchetti, professor of international economics at Brandeis University and a former director of research at the New York Fed. "If financial conditions don't start to improve dramatically," officials might have to cut before their January gathering, he said.

"Incoming information suggests that economic growth is slowing, reflecting the intensification of the housing correction and some softening in business and consumer spending," the FOMC said. "The committee will continue to assess the effects of financial and other developments in economic prospects and will act as needed to foster price stability and sustainable economic growth."

The central bank also said some "inflation risks remain" and probably was reluctant to reduce borrowing costs at all, said Vincent Reinhart, former director of the Fed's Division of Monetary Affairs and now a resident scholar at the American Enterprise Institute.

Yesterday's decision, which matches the median forecast of economists surveyed by Bloomberg News, wasn't unanimous. Boston Fed President Eric Rosengren voted in favor of a half-point cut.

The Dow Jones industrial average slumped 2.1 percent to 13,432.77, while the yield on the two-year Treasury note — among securities most sensitive to official interest rates — declined about 25 basis points to 2.92 percent at 4:33 p.m. in New York.

"When stocks go into a tailspin after you release your press statement, you know as a central banker that you didn't meet the market's expectations," said Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi UFJ Ltd. in New York. "There were rumors today about the possibility of 50 basis points, so that was a modest disappointment."

The benchmark rate is now at the lowest level since January 2006. Bernanke, 53, who succeeded Alan Greenspan as chairman the following month, continued a series of increases that lifted the federal funds rate to 5.25 percent by June last year.