Liquidity describes how easily an asset can be sold without losing value. For instance, US government debt is highly liquid because the market for it is large and stable. US debt can be sold for its entire value almost instantly. On the other hand, a rare piece of art is illiquid. In order to sell a sculpture for its full value, an auction must be arranged, art connoisseurs must be notified, and payment must be collected.
Liquidity is a valuable attribute because it allows an investor to change her mind about an investment quickly and exit a market if she loses confidence in it. As such, there is often a tradeoff between the liquidity of an asset and its rate of return. The importance of liquidity is especially apparent in a liquidity trap scenario.