It doesn't really mean
anything in particular (it's just another IP in the 127.0.0.0/8 block).
The reason it's used as the IP for your hostname is explained in Section 10.4
of the Debian Reference Manual.
Some software (e.g., GNOME) expects the system hostname to be resolvable to an IP address with a canonical fully qualified domain name. This is really improper because system hostnames and domain names are two very different things; but there you have it. In order to support that software, it is necessary to ensure that the system hostname can be resolved. Most often this is done by putting a line in /etc/hosts containing some IP address and the system hostname. If your system has a permanent IP address then use that; otherwise use the address 127.0.1.1.