How to re-insulate space between window trim and wall?
In the case of the fibreglass, it likely looks shrunken because of the way the batting was pressed into the shim space (gap between the window and wall frame) when the window was installed. As far as insulating the window goes, you can choose to remove the batting and replace it with batting that has a better R-rating (i.e. Roxul) or fill the void with low expansion spray foam insulation (i.e. Tremco Exoair L.E.F., or Nuco PF-100) (based on methods of install provided by my window company's Install team). Combining the two would be redundant as the batt can displace the expansion area of the foam and vice versa. Either option can work well on its own.