Friedrich Schlegel’s remarks about poetry and reality are notoriously baffling. They are often regarded as outlandish, or “poetically exaggerated” statements, since they are taken to suggest that there is no difference between poetry and reality or to express the view that there is no way out of linguistic and poetic constructions (Bowie). I take all these responses to be mistaken, and argue that Schlegel’s remarks are philosophical observations about a genuine confusion in theoretical approaches to the distinction between fiction and reality. The confusion at stake involves the assumption that this distinction is and must be fixed independently of the ordinary practices of using these terms to mean certain things in specific situations. And this assumption itself is grounded fundamentally in a confused picture about the way language works. I argue that this confused understanding of the distinction between fiction and reality is not an object of the past, but a picture that is still shaping a central strand in the contemporary debate in philosophical aesthetics about our emotional responses to fiction. And while I do not use Schlegel’s approach to argue against this contemporary view directly, I suggest that his philosophical method includes the resources for unraveling a central confusion in this contemporary debate.