Understanding Monetary Policy and Interest Rates becomes easier when the ideas are illustrated. A great way to do that is by looking at some Yield Curves.
Yield curves are nothing more than plots of interest rates as of a specified time based on maturities.
The "based on maturities" part of that definition gets clearer if you think about "money markets" being where different financial products are bought and sold.
Helpful Note: Financial markets deal in dozens of different bonds, paper, bills, instruments and notes. It can get overwhelming. Keep it simple by remembering they're all just products. How they differ from one another isn't important. Every market, including money markets, has buyers (someone wanting a financial product that pays a specified amount on a certain future date) and sellers (someone providing the financial product that will do that).
One of the ways financial products differ from one another is by their term. One product you buy today might not pay-off for one year while another might not pay-off for 20 years (these time periods are called the product's "term").
Obviously the "price" you pay for a product with a one-year term will not be the same as what you pay for a product with a 20-year term. And what makes them different is the interest rate for one won't be the same as the interest rate for the other.
Things get very interesting (and even exciting) when you think about the relationships between these differences and how they change over time. That's when Yield Curves become your new "best friend!"
A picture of the financial markets in January 2004 looked like this. It's how the "Yield Curve" looked after the financial markets closed on January 6, 2004.
See how Interest Rates for Long-term products are higher than Rates for Short-term products. 
Is this how Economists predicted the picture should look? Why is that?
Part of your answer probably considered whether risk increases over time. In other words, don't the chances of something bad happening increase as you wait longer for something to happen?
And aren't there two perspectives on this problem? One might be things outside your control such as inflation or the price of oil. And the other might be things you can control (or at least do something about) such as whether the seller of the financial product you bought will pay what's owed when it's owed.
It also helps to remember that (1) 2004 was an election year and a robust economy usually helps incumbents get re-elected and (2) job growth and the stock market both weren't healthy back then.
With that in mind, it makes sense that the Yield Curve was up-sloping when 2004 began. Monetary Policy-makers at the Federal Reserve were trying to stimulate the economy by keeping short-term interest rates low while long-term financial products' buyers wanted to be compensated with higher rates for their added risks.
The history books report the economy boomed during 2004, 2005 and 2006. As you remember, the Federal Reserve System's Federal Open Market Committee was raising short-term interest rates during this time to keep things from over-heating, that is, check inflation before it got out of hand.
So, what did the Yield Curve look like in January 2007 after the economy sizzled for three years and the Fed was raising interest rates? Would you expect short-term rates to be higher and long-term rates be even higher? Isn't that what our theories and history tell us it should look like? Well, here is the January 2007 yield curve...
Surprise! Not what you were expecting, right? Looks backwards, doesn't it?
Short-term rates, as expected, went up a lot (from about 1% to about 5%), but long-term rates went down a little bit. What we see is a Yield Curve that is "inverted" from its customary form.
If the housing industry thrives on cheap long-term credit, do you see why it over-heated?
But what explains this? Have our economic theories stopped working? The answer is no, but what went wrong was we didn't consider how the Law of Supply and Demand effects the Yield Curve.
During the three years from 2004 through 2006, the global economy was also booming. Foreign investors needed a place for their surplus profits. And there was no better place then the US economy.
One explanation then for why the Yield Curve inverted is that as fast as the Fed was "drying up" investable funds by increasing short-term interest rates, the supply side of the market was being flooded with funds from foreign investors. The result was short-term rates went up because of the Fed's actions, but long-term rates stayed low because the supply of funds kept increasing.
All this should have warned us that a "correction" was on the way. It wasn't a question of "If," but "When?" And sure enough, the excesses of too much cheap credit caught up with the housing industry and claimed another "victim," foreign currency exchange rates.
If financial markets are "adjusting" and our theories still work, we would expect now to see a "normal" upward-sloping yield curve. Let's look at the Yield Curve about a year later in December 2007... 
That's more like it, isn't it?
Short-term rates are lower than what they were a year ago, but that's because the Federal Reserve System is trying to ward off the nasty effects of the "adjustment" we're going through and avoid the dreaded "R" word (recession). But, best of all, the "big picture" looks "right" again.
Now, let's take a look at what the recent financial turmoil has done to the Yield Curve.
Remember that Fiscal and Monetary policy actions are aimed at avoiding a slowdown by making credit available at affordable interest rates.
And the "market" for this credit is businesses, consumers and financial institutions needing more cash in order to make loans.
What are the "take-aways" from all this? As a future business manager, what can you learn to help you make good decisions?
One is that "abnormal" conditions (such as an inverted yield curve) produce abnormal results. If something is "too good to be true, it probably isn't true." Manage with a long-term perspective; don't get caught up in short-term frenzies that are this week's "once-in-a-lifetime" opportunity.
The last four years have also made it clear that monetary policy is an "indirect tool" and vulnerable to external forces. At best, it takes six to nine months for monetary policy changes to work their way through the system. Consumer and business spending patterns don't respond immediately after the Fed signals a policy change. A message that the US economic policy is subject to factors outside its boundaries and control also comes through. The implications of this new reality are not yet fully understood.
Last, but not least, understand that while the nature of change can't always be predicted, the pace of change is increasing at an increasing rate. When the economic historians assess the first decade of the 21st century, they may observe that policy-makers were caught off-guard by how fast and by how much a globalized economy can change. Business managers will also have to re-double their efforts to keep pace with this 24/7/365 (366 in 2008) world that moves at the speed of light and with a click of the send key.
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