The Economic Journal, 91 {March 1981), 58-74 Printed in Great Britain PROJECT APPRAISAL AND FOREIGN EXCHANGE

It is a commonplace that the shadow (or accounting) prices appropriate for use in project selection in an economy depend on the 'market ' imperfections that are judged to be present. What has received far less attention in the theoretical literature on social cost-benefit analysis is the fact that they depend as well on the response of the government to the perturbation which the undertaking of projects entails. It is convenient to suppose that the government simultaneously optimises with respect to all variables within its control, and it is the implication of this supposition that has been explored in much ofthe recent literature on project evaluation. But as a model of government behaviour it is not persuasive. Moreover, the analysis of government behaviour becomes critical in situations where prices and wages are not perfectly flexible. This paper is concerned with economies in which markets are characterised by price rigidities and where governments behave systematically, but not necessarily optimally. In such a world we wish to obtain rules for project selection. The analysis is conducted in the context of the foreign exchange market. W