In its first unanimous decision this year, the central bank said it was keeping its target for the federal funds rate, the interest that banks charge on overnight loans, unchanged at 2 percent.
Some investors had hoped the Fed would cut rates after financial markets were stunned by investment bank Lehman Brothers' failure over the weekend to find financing or a buyer.
Stocks initially slumped on the Fed announcement with the Dow Jones industrial average dropping by about 100 points. However, in late afternoon trading the Dow was up nearly 84 points as investors took heart that the central bank did not believe the economy was in as much trouble as many had feared.
In the statement, the Fed said "strains in financial markets have increased significantly and labor markets have weakened further."
The central bank said it also remained concerned about inflation pressures, however.
The Fed said it would closely monitor economic developments going forward and would be prepared to "act as needed to promote sustainable economic growth and price stability."
Many private economists had expected the Fed would leave interest rates unchanged, but would signal the possibility of further rate cuts by hinting that market turmoil had tilted the balance of risks to weaker growth and away from the threat of inflation.
"The downside risks to growth and the upside risks to inflation are both of significant concern to the committee," the Fed officials said.
"I just don't think this is a realistic statement on the part of the Fed," said David Jones, head of DMJ Advisors in Denver. "It is clear that the downside risks to growth outweigh the risks of inflation."
If the market turmoil and other forces hitting the economy result in weaker growth than the Fed is expecting at the moment, Jones said he still believed the central bank will implement two quarter-point rate cuts before the end of the year.
The Fed's decision to leave rates unchanged came on a day when it moved aggressively to bolster confidence by injecting $70 billion in extra reserves into the financial system. The Fed did that during its normal open market operations which are handled by the Fed's New York regional bank.
It marked the first Fed meeting this year when there has not been one or two dissents from Fed officials who objected that the central bank was not focusing enough attention on inflation.
Richard Fisher, president of the Dallas regional Fed bank, had dissented for five consecutive times before this meeting. He had argued at the past two meetings when the Fed had left interest rates unchanged that the central bank should be increasing rates to fight rising inflation pressures.