hide_cursor is for simply allowing or not allowing MAME to grab and hide the Windows mouse cursor when you enable mouse input. It is set to on by default, which is equal to how MAME dealt with it in a previous version. Lightgun cursors are still there, they move at a different speed than the OS cursor.
One of the MESS developers wanted this feature for chess games, but I can think of other examples too.
Such as: I often play games in windowed mode, using plain PC keyboard as input. If I want to play Rave Racer or Ridge Racer 2, there's no easy way to choose the advanced course with keyboard since the selection thing goes way too fast. It's doable with mouse, so I just start the game with mame gamename -mouse -nohc, and can play the game and let attract mode run in the background without me having to alt-tab out of MAME every time cause it stole the OS mouse cursor.