"But that's not how real life works at all, right?"
How real life works is always a plausible interesting goal, but it's very often at odds with a bunch of other valuable goals for players.
A particular sharp example of this is sports video games. It might well be interesting (and certainly realistic) to simulate bad referees in a sports game. Horrible blown calls by tennis line judges, or missed calls by basketball refs, or bad umpire calls on pitches. Real-life soccer makes working the refs and their inability to see everything an art form, as far as I can tell.
Perhaps that's interesting, but the irony here is that real life refs are actually bad simulations of the original perfect game code in the first place, from a certain point of view. I think debates about the use of instant replay in sports gets at the heart of this, and one could imagine using real-time AI to help refs taking this conversation much further.
I think the sports case is a particularly sharp example, but it definitely holds with all sorts of choices in games.
For Animal Crossing in particular, I remember when I finally played it, it struck me after a while how much it had in common with recent MMOs (Everquest and World of Warcraft) that I had had fellow game developer friends have their lives severely disrupted by. And when I played the original Animal Crossing, I remember noticing specifically how careful the designers were in having players use up every bit of interesting content in a day after 45 minutes or an hour, so that eventually you'd run out of things to do, and that was the game's signal to put it down and pick it up again the next day. And I remember being struck by how intentional it was, and how humane it was... particularly given their goal of wanting to make a game that was asynchronously coop (where different family members could play in the same shared space at different times of day and interact asynchronously). As a game designer myself, I really respected the care they put into that.
Anyway, that's my immediate thought on seeing this (fascinating, valuable) experiment with LLM dialogue in Animal Crossing. The actual way NPCs work in these games as they are has been honed over time to serve a very specific function. It's very similar to personal testimonials by paid actors in commercials; a human expressing an idea in personal dialogue form triggers all sorts natural human attention and reception in us as audience members, and so it's a lot more sticky... but getting across the information quickly and concisely is still the primary point. Even dialogue trees in games are often not used because of their inefficiency.
I totally think that there will be fascinating innovations from the current crop of AI in games, and I'm really looking forward to seeing and trying them. I just think it's unlikely they will be drop-in replacements for a lot of the techniques that game developers have already honed for cases like informational NPC dialogue.