I maintain that fantasy is essential to a child's development. There's a wonderful treat that comes with language; we can create an entire world in our heads, without any of it becoming real. Once pre-school children catch on to this, their mind catches fire with complexity.
Listen to a toddler's play-talk some time, "And mommy will pick me up and we will stop at McDonald's and I get to pick out a Happy Meal and then we will go back in the car and drive to the STORE to get ice-cream and then we will go HOME and we will watch TV until daddy comes home and he will tickle me and I am a good boy and then it will be Time to Go to Bed but I have to brush my teeth first don't forget to wash your hands TEDDY is on my bed." The toddler is rehearsing a future event. I can't tell you how important this is to human development. Without it, language is merely a series of commands with no forethought, like we use with a trained animal "Sit here", "Eat this." I've read tragic stories of deaf children who missed those early development years, and language is NO playground for them. They cannot plan. They cannot anticipate.
So how does fantasy play in to this? Somewhere between the ages of two and three, the child starts to distinguish between a manufactured reality from words, and the real thing. The fantasy plays vivid within their own minds. And to think, this is done with words alone. The child delights in rehearsing the story in their minds, and even makes up his own fantasies and plays them out in his head. So when we see the child dancing around Santa Claus, or asking if the Tooth Fairy will remember, they know deep down that this is a temporary bridge to the fantasy world. We are giving them a few moments of delight.