cinematic tradition

We're talking about a cinematic tradition running from The Wizard of Oz through Jacob's Ladder, and quite a lot of other interesting films in between. Did you hate The Usual Suspects because its story turned out to be largely invented by one of the characters? I suppose you also object to the flashback structure of Citizen Kane and Rashomon.
Our dreams tell a lot about us, and exploring Diane's subconscious deepens rather than undermines the story of the film. The fact that so much of the story exists offscreen, that we feel Diane's story while only seeing a fraction of it is a testament to the strength of Lynch's skills as a filmmaker AND a writer.