Ghost of a Tale takes place in a medieval world inhabited by several species of anthropomorphic animals, many of which inhabit their own kingdom: the lore includes mice, rats, frogs, crabs, badgers, hawks, spiders, leeches, magpies and various undead creatures.

The game is set centuries after a cataclysmic event known as the War of the Green Flame. During this time, a mysterious ball of emerald fire of unknown origin swept across the world, killing all who stood against it and raising their bodies into an ever-growing undead army. At the height of the conflict, the mouse kingdom sent an envoy to the flame attempting to save their home by revealing the weaknesses of others, but the being could not be reasoned with and destroyed most of their land regardless.

In the end, it was the rat army who rose up to finally defeat the entity, becoming the heroes of the war, and expelled the mice from the land's governing body forever for their treachery. Hundreds of years later, the exact history of these events has become clouded in time, with the only true account being held in the oral traditions of a group of magpies called the Truth Sayers, who live in a tower on an ancient island.

At the beginning of the game, Tilo mouse is thrown into a dungeon by rats: he must escape from his prison and the surrounding lands. The many adversaries Tilo faces are much stronger than him: the courageous little mouse will need to be smart, stealthy and agile to succeed!