When people dream, they are “completely out of touch with reality” and they take totally seriously the most fantastic and improbable perceptions. When people are psychotic, they do pretty much the same thing. Could there be a connection? Actually there seem to be many connections, some of which are discussed at http://www.hgi.org.uk/archive/psychosis.htm.
Dreaming and creativity are highly associated. I know some people who have questioned the notion that psychosis (considered an illness) could be linked to creativity (considered one of the highest human functions) but the evidence just keeps getting stronger. Just this morning, I was reading in one book that in testing brain differences, physiological differences, and cognitive differences, the very strongest predictor of a schizophrenia diagnosis was being low in a thing called “latent inhibition” which is the ability to screen things out of awareness that were previously tagged as irrelevant. Most of the places I have seen this discussed, it is looked at as nothing but a “brain defect” that predisposes a person to psychosis. But is being low in latent inhibition always a bad thing? It turns out not: highly creative people are also low in latent inhibition! Of course, those who are successfully creative have learned how to handle this difference.
More on this at http://blogs.psychologytoday.com/blog/beautiful-minds/200903/schizophrenic-thought-madness-or-potential-genius or in more detail at http://pantheon.yale.edu/~sbk22/Scott_Barry_Kaufman/Publications_files/Kaufman%20%282009%29.pdf