The invention discloses a technique for producing liquid fuel by graded conversion of sludge, comprising the steps of proportionally mixing sludge and solvent 1, performing extractive reaction at certain temperature, and isolating to obtain gas 1, extraction liquid mixture and extraction residue, subjecting the extraction liquid mixture to phase isolation to obtain oil and water, distilling the oil to obtain the solvent 1 and light oil 1, performing liquefaction reaction on the water, extraction residue, a catalyst and solvent 2 under certain conditions, and isolating to obtain gas 2, the solvent 2, light oil 2, heavy oil and residue. Light organic components in sludge are directly extracted as liquid fuel under mild temperature and pressure; water and residue produced by extracting are mixed for liquefaction reaction under high temperature and pressure to further produce liquid fuel, to be specific, organic components in the sludge are isolated and then subjected to graded conversion through two-step process, and high-added-value liquid fuel is finally obtained.