The US Federal Reserve threw a surprise $800billion (£517 billion) lifeline to Wall Street's fractured credit markets yesterday, in the latest sign that Washington has been stunned by the speed and severity of the American economic recession.

The new funds bring to $1.7 trillion the total taxpayer money used to bail out America, with another $500 billion of tax cuts in the pipeline.

As Washington sought to accelerate federal handouts, European lawmakers were drawing up their own financial stimulus package, although details of the size of the continental rescue were unclear.

America's latest state-aid fund, which will feature two tranches, has been designed to make it easier for Americans to obtain car, credit card and student loans. The first chunk, of $200 illion, will be used to lend money to holders of distressed debt that is backed by consumer or small business loans. Given that the troubled bonds are effectively untradable, the Fed is offering to lend funds using the debt as collateral.

The measure means that banks can secure new capital but do not have to sell and take a subsequent loss on the bust bonds. This part of the scheme is to be called the Term Asset-Backed Securities Loan Facility, or Talf.

The US central bank said it would use a second tranche to start buying $600 billion of government-sponsored enterprise-backed debt to try to thaw frozen credit markets.

This latest bailout exceeds the $700 billion rescue fund created last month to provide emergency capital to US banks, known as the Troubled Asset Relief Programme, or Tarp. It also comes on top of the $158 billion of tax rebates returned to Americans last May and plans for $500 billion of new tax cuts from Washington.

Wall Street received grim new evidence of the speed at which the American economy is deteriorating. Revised growth numbers showed that GDP for the third quarter had fallen by an annualised 0.5 per cent, rather than by 0.3 per cent, as previously stated. Worse, consumer spending numbers showed the steepest decline for 28 years. According to the Commerce Department, consumer spending, which fuels two thirds of US economic activity, fell by 3.7 per cent in the third quarter, rather than by 3.1 per cent, as previously estimated.

Separately, Brussels was making final a recovery plan and financial stimulus, to be announced today, that is designed to protect jobs, encourage consumer spending and offer soft loans to key industries. The European Commission said it would temporarily relax key competition rules. A draft of the plan suggested that the European Central Bank had room to ease monetary policy. The bank has signalled that it may cut rates on December 4, and markets expect a reduction of up to 75 basis point from 3.25 per cent.

Explore Economics

• Pre-Budget Report 2009

• Budget 2009

• World Economic Forum

• The Times MPC

Times Recommends

• Lies and cover-up at MG Rover exposed by report
• High oil prices push manufacturing costs up
• Primark founder steps down as chief executive