Hi, I'd like to help you with your question.
Your mother in law's behavior is not about you. This is how she sees the world. No matter how great your kids are or how wonderful a mother you are, your mother in law will still act this way. Somewhere in her life, she was taught that it is ok to treat people with disdain and ignore the feelings of everyone around her. She has intimidated her own children and continues to try to control your family.
When someone chooses to act out in this manner, there is little you can do to change them. It appears your mother in law has little to no insight into how harmful her behavior is. When someone does not know they are doing wrong or doesn't care, then they have no motivation to change. That leaves everyone else with no choice but to react to what the person is doing.
As her son, your husband should be dealing with his mother. He needs to tell her that her behavior towards your children and the two of you is unacceptable. He also should tell her that if she cannot treat the children as equal, then she is not allowed around them. But if he will not do that, you may need to tell your mother in law instead. Ask your husband to back you up. Then decide how much contact, if at all, you are willing to tolerate from her. If seeing her is important to your children, then you can place limits on her behavior. If she tries to provide a gift for one child, for instance, then tell her she is no longer allowed to bring any gifts for any child.
You and your husband may want to consider therapy to help you overcome the conflict around his response to his mother's behavior. Having a spouse who backs down from protecting the family can breed anger and resentment. Leaving the response up to you also can drive a wedge in your marriage, which is hard to cope with without help. To find a therapist, talk to your doctor about a referral. Or search on line at http://therapists.psychologytoday.com/rms/.
If you have not already, talk with your children about grandma's behavior. You have older children so they probably understand already. But it doesn't hurt to include them in the conversation. Explain that grandma sometimes acts in ways that are not nice. Try to avoid blaming her or appearing angry at her. That will only confuse the kids on how they should act. Tell the kids they can come to you if they feel confused or hurt. Tell them you are working on the problem and let them know they are loved. Include your husband so he can see the effects first hand. It may help him overcome his fear of his mother.
I hope this has helped you,