Quoting Schickel (in regards to Lynch) "...to deny us the false comforts of falsified history." One component of the film is that it is a caricature of the past and how we in the present fondly look back upon it.
I like Liz's theory of it being a 'dream'- but going with the idea that it is a caricature, I think that Jeffrey and Sandy did live out all those events in some capacity, but like all memories, details begin to to contort and exaggerate as time goes on...and what we, the viewer, saw was the Memory of the event.
1) Jeffrey's dad's recovery time
In the beginning the dad was laid up in the hospital in an awful way, and at the end he was just fine. People in his condition don't heal that quickly. An indication of a long period- maybe Spring to Spring or Spring to Following Summer.
2) In Dream's Lyrics
'I close my eyes then I drift away into the magic night..."
3) Time period (?)
It feels like a mix of the 50s, 70s and 80s. The way the town is laid out feels very 50s. But the clothes and hair fall more into the 70s-80s mix.
4) Blue Velvet lyrics
'But in my heart there will always be precious and warm a memory thru the years.."
And whether it be a dream of Jeffrey's or a daydream on a sunny afternoon of Jeffrey's, I think most of us can agree that on some level the film is a representation of memories and the falsity we give them, the exaggeration that time lends them, and the incongruities the mind gives it.