T.,
I know this is an old one and perhaps it has already been solved, I just wanted to give you the perspective of the child in this situation. I grew up in this same situation! My Grandmother is very much a narcissist. I don't know that I would say she is a pathological liar, but she definitely "remembers" things to fit the way that makes the most sense to her and that will benefit her the most. She will say that things were said, even if you never said them, and fight to the death to defend what she remembers. She always did way more then my parents wanted her to. She "spoiled" us with clothes, food, treats, money, breaking our family rules all the time...anything to prove her love and "look" good in our child eyes. She feels she is entitled to more love then others because she gave so much, but the funny thing is I love her just the same as my other grandma, who did very little in the gift giving, but she would never understand that:)
Growing up I realized that she manipulated my sisters and my mother and I all the time, so she could get her way.(which usually was to be the center of our lives)
However I realized very young a few things; 1. she did not own me, she could not buy me.
2. the way she showed and received love was through gifts.
3. she was lonely,
4. I could be gracious for the gifts and loving towards her without letting her hurt me.
5. I have control over what goes in my body and what I allow myself to do. (This one took a while to learn, cause what child wants to turn down sweets? But after I grasped the concept of good food and junk food, it was a lot easier.)
Some things you might want to talk to your girls about are,
Different ways people show love. (gifts in my grandmas case, look up the five love languages)
When a gift is given, one cannot require something in return. You give a gift to show love not to expect to feel loved back.
They are in charge of themselves. Just because someone gives you a lot of things or does a lot of thing for you, does not mean that you owe them anything but graciousness, they do not control you. Just because she wants to take them to the movies doesn't mean they have to go if they don't want to. No one should make them do things they don't want to do, (except a Mom and a Dad that love them and are helping them grow and learn.)
Explain that grandma doesn't have a lot of money. so to keep her safe, they need not tell her all the fun things that you do with them or get them, because she will try to do more. If she asks, then be honest, but try to talk about other things.
Talk about nutrition with them, how they feel lousy after eating junk food and how good they feel after eating balanced all day. They control what goes in their body, just because she has it there and is offering, they do not have to partake.
About the journal, I would tell MIL that your daughter would love to have the journal at your house cause she wants to write in it more often. But if she wants it at her house then you will just get her another one:) After you tell your daughter that Grandma is reading it, encourage her to only write things that she wouldn't care about any strangers reading.
So even though my Grandma "spoiled" us, she did not "ruin" us. I knew who really cared for me and loved me unconditionally, my Mom and Dad. And they did a fabulous job of explaining her to me and helping me realize what her needs were, how I could help fulfill them with out getting hurt.
I have a very good relationship with her now. I am never fake, but I do not go very deep with her, I can't completely trust her not to take what I say the wrong way. We mostly talk about heath and weather and what the kids are doing, what I am doing, just not about feelings or ideas. Kind of superficial, I know, but it keeps her happy and at peace and I don't have to worry about her getting revenge on me by "cutting me off" and her being left all alone.
She may spoil them but because you love them and are aware of this odd but not so rare situation, you can help them not turn sour:) Just be active and open in talking about Grandma not rude or demeaning, just honest. And talk with them about who they want to be when they are grown, and they will ripen just beautifully:)
Good Luck
E.