But the loan depends on Turkey cooperating with US troops in Iraq and with the International Monetary Fund.
In a letter to Congress on Tuesday, the US State Department said it decided to go forward with the aid package to support Turkey's "economic reform process" and to cushion the economic shock from the Iraq war.
"The US attaches significant importance to a strong, economically stable, and democratic Turkey as a hopeful model for the Islamic world.
Ankara is considering sending troops to war-torn Iraq, despite a statement by Baghdad's interim foreign minister Hoshyar Zebari that Turkish troops could further destabalise the country.
Turkish foreign minister Abd Allah Gul said on Tuesday Ankara would decide this month whether it would send forces to Iraq.
"Such a model is particularly valuable following regime change in Iraq," the letter said.
The State Department said it was transferring $1 billion to the Treasury Department to finance the $8.5 billion loan package, which will be disbursed in tranches over an 18-month period.
The first payment under the programme could take place as early as 20 September, the letter said.
But before each disbursement, Turkey must meet certain conditions, from cooperating with US forces in Iraq to fulfilling its obligations under a $16 billion loan programme with the International Monetary Fund.
The funds will be used to service Turkey's external and domestic debts, "giving priority, where possible, to debt owed to the United States and to international financial institutions," the letter said.
Turkey has a substantial short-term debt with large monthly debt servicing requirements.
The State Department said the US loans would help meet "these rollover requirements in the near-term."
President George Bush has offered the money to Ankara despite its refusal to allow US troops to use Turkish soil during the war in Iraq.
US soldiers were not allowed to
attack Iraq from Turkish soil
Washington now wants Ankara to contribute troops to a peacekeeping force in postwar Iraq, and Turkish Foreign Minister Abdullah Gul said on Tuesday the government would decide this month whether to oblige.
Some American lawmakers, still upset at Turkey for refusing to open its bases for the invasion of Iraq, have suggested holding up US aid in protest.
But the State Department said Turkey has provided "valuable assistance" in Iraq, from facilitating the delivery of humanitarian supplies to helping re-supply US forces.
Meanwhile, Turkey is planning to wipe out six zeroes from its inflation-hit currency.
The Turkish government has started technical preparations to remove the zeroes from the embattled Turkish lira next year, Finance Minister Kemal Unakitan said on Tuesday.
"We are aiming at inflation of about 12% for the end of 2004. At that time we are also planning to delete zeroes from the lira. The target is six zeroes," Unakitan said.
Chronic inflation and financial crises have hit the Turkish currency for decades. As a result, the smallest coin today is worth 25,000 lira, while the biggest banknote is of 20 million lira.
Ankara has in recent months recorded progress in pulling down inflation, with the help of a $16 billion deal with the International Monetary Fund.
The inflation rate stood at 24.9% in August.