Memories of the economic warfare of the interwar years led to an international conference at Bretton Woods, New Hampshire, in 1944. At the close of World War II there was a desire to reform the international monetary system to one based on mutual cooperation and freely convertible
currencies.There was a need for a system that fixed currencies relative to each other, but did not fix each currency in terms of gold. The Bretton Woods agreement solved this problem by requiring that each country fix the value of its currency in terms of an anchor currency, namely the dollar (this established the “par” value of each currency and was to ensure
parity across currencies). The U.S. dollar was the key currency in the system, and $1 was defined as being equal in value to 1/35 ounce of gold. Since
every currency had an implicitly defined gold value, through the link to
the dollar, all currencies were linked in a system of fixed exchange rates.
Nations were committed to maintaining the parity value of their currencies within 1 percent of parity. The various central banks were to
achieve this goal by buying and selling their currencies (usually against the dollar) on the foreign exchange market. When a country was experiencing difficulty maintaining its parity value because of balance of payments disequilibrium, it could turn to a new institution created at the Bretton Woods Conference: the International Monetary Fund (IMF). The IMF was created to monitor the operation of the system and provide short-term loans to countries experiencing temporary balance of payments difficulties.Such loans are subject to IMF conditions regarding changes in domestic economic policy aimed at restoring balance of payments equilibrium.