I recently tried to use AI to generate NPC dialogues, which saved time, but also caused problems such as inconsistent style and confusing logic. Whether AI generation can completely replace manual writing is still worth discussing.
Theoretically using LLMs for runtime NPC dialogue is interesting, but it seems extremely difficult to make it play nice with the rest of the game, and has a host of other issues that there's no reason to expect can ever be resolved.
Using it to create predefined dialogue? No, never. Be an actual artist.
I agree with DStecks, no matter how much people try and train AI to do things it cannot replace real human content. Actually, Itch has a great community of dialog writers, musicians, and artists for video games. If you want dialog to practically appear out of nowhere, ask the community. A lot of aspiring artists are willing to work for free in order to be recognised.
In my opinion, runtime dialog brings up it's own host of moral dillemmas. See AI dating sims.
This is very low on the list of issues with runtime AI dialogue, but if the idea is to increase immersion, AI chatbots are such a novelty that it's going to wind up making the player a lot less immersed - to say nothing of how they present an open invitation to anyone who wants to poke at the edges of the simulation; this should be obvious to anyone who ever tried typing obscene instructions into a text parser game.
Speaking of text parsers, one of the big reasons why runtime AI dialogue just isn't worth trying to corral into a game is that the primary application - being able to ask an NPC questions - is something games have been capable of since before I was born. A chatbot means you don't have to write out a huge set of responses, but it also means you can't know for sure what your NPCs will say, and that's... problematic.