So there was this illustrated book I had when I was younger that had the aforementioned plot. I'm almost positive there was a castle involved within the dreams, plus the children all came from different socioeconomic backgrounds...I think one of the children may have been a young girl who worked at a laundry?
One key detail I can remember was one of the stories being called "Ms. Beppo's Bag" and it was about an old woman who wanted a bag she could fit everything into, and her wish was granted. However, the bag started swallowing up people also, including Miss Beppo herself. Another key detail was a quote in the book that always stuck with me, and it read something like the below:
"Sometimes there is grief so great, even death keeps its distance."
I think the illustrations were in black and white, or very pale pastel colours. They were very beautiful and vintage-looking, almost drawing-like in nature.
No worries if no one can find it, just thought I'd take a chance!
UPDATE: After running into many paywalls (FUCK the Irish Times, useless newspaper) I can confirm that this book was The Story Giant by Brian Patten.