Willow is turned into a ghost. Throughout the entire episode, she can't touch anything (can't turn the pages of a book, etc.), yet towards the end when she and Giles go to Ethan's shop, and she leaves, you can hear that she opened and closed the door, even though she can walk through walls and can't actually touch the door. The curtain moves when she leaves too.
In addition to singing "Rest in Peace," James Marsters also played the song's guitar track.