Use of class definitions inside a method in Java

Those are called local classes. You can find a detailed explanation and an example here. The example returns a specific implementation which we doesn't need to know about outside the method.

1. The class can't be seen (i.e. instantiated, its methods accessed without Reflection) from outside the method. Also, it can access the local variables defined in testMethod(), but before the class definition.

2. I actually thought: "No such file will be written." until I just tried it: Oh yes, such a file is created! It will be called something like A$1B.class, where A is the outer class, and B is the local class.

3. Especially for callback functions (event handlers in GUIs, like onClick() when a Button is clicked etc.), it's quite usual to use "anonymous classes" - first of all because you can end up with a lot of them. But sometimes anonymous classes aren't good enough - especially, you can't define a constructor on them. In these cases, these method local classes can be a good alternative.

This is called a local class.

2 is the easy one: yes, a class file will be generated.

1 and 3 are kind of the same question. You would use a local class where you never need to instantiate one or know about implementation details anywhere but in one method.

A typical use would be to create a throw-away implementation of some interface. For example you'll often see something like this:

  //within some method
  taskExecutor.execute( new Runnable() {
       public void run() {
            classWithMethodToFire.doSomething( parameter );
       }
  }); 

If you needed to create a bunch of these and do something with them, you might change this to

  //within some method
  class myFirstRunnableClass implements Runnable {
       public void run() {
            classWithMethodToFire.doSomething( parameter );
       }
  }
  class mySecondRunnableClass implements Runnable {
       public void run() {
            classWithMethodToFire.doSomethingElse( parameter );
       }
  }
  taskExecutor.execute(new myFirstRunnableClass());
  taskExecutor.execute(new mySecondRunnableClass());

Regarding interfaces: I'm not sure if there's a technical issue that makes locally-defined interfaces a problem for the compiler, but even if there isn't, they wouldn't add any value. If a local class that implements a local interface were used outside the method, the interface would be meaningless. And if a local class was only going to be used inside the method, both the interface and the class would be implemented within that method, so the interface definition would be redundant.