What does “localhost name resolution is handled within DNS itself” mean?

I know that the Windows hosts file maps host names to IP addresses. But there is no mapping for localhost. Instead it has a comment that says this:

# localhost name resolution is handled within DNS itself.
#   127.0.0.1       localhost

I don’t understand this. Where is this “DNS” that handles this resolution? Is it a program somewhere in Windows OS? Is it outside of Windows? Does it have a config file? How is this being done?