How does Lily react to the word "hippo"? Why does she react that way?

In the story, Lily giggles when she hears the word "hippo." To Lily, the word is a strange one, and this is why she reacts the way she does.
In the story, each newchild is provided with what is called a "comfort object" at birth. The comfort object is used primarily as a means of emotional support by all new babies. Lily's comfort object is a stuffed elephant, and when she turns eight, it will be taken away from her and given to a younger child. Her brother, Jonas, had a stuffed bear as a comfort object when he was younger.
The text tells us that these comfort objects consist of "soft, stuffed, imaginary creatures." If the soft toys resemble imaginary creatures to the children, we can infer that they have never actually seen real animals. In fact, a conversation between Lily and the rest of her family substantiates this interpretation.
When Lily expresses her frustration about a boy from a visiting childcare group, she and Jonas agree that the boy acted like an animal when he disobeyed the rules. However, it appears that neither Jonas nor Lily knows what an animal is. All they know is what they have been told about animals.

“That’s right,” Lily said, laughing too. “Like animals.” Neither child knew what the word meant, exactly, but it was often used to describe someone uneducated or clumsy, someone who didn’t fit in.

So, part of the reason Lily reacts the way she does to the word "hippo" is because it represents the strange name of a strange animal she has never seen. When you think about it, it's quite disturbing that both Lily and Jonas live in a world so heavily censored that they have no idea what animals really are.