One example that comes immediately to mind is if you're trying to develop more than one website on your local server, and wish to use name-based virtual hosting to have them all on 127.0.0.1.
I don't know why you'd do that if you had any network clue; I'd just throw another RFC1918 network on the fire and hack my local DNS servers appropriately. But then I'm unfazed by BIND config becase I do it every day for a living. If you didn't feel like doing battle with your local DNS, then the Testing Domains hack is quite elegant.
I'm sure other people will be able to think of other applications.
Edit: no, that's not a pretty URL issue per se; doing name-based virtual hosts requires that the different sites are accessed via different domain names, all of which resolve to 127.0.0.1. Using http://localhost/site isn't the same, as each site will then have to be moved up a level before it's rolled into production.