My mother in-law gets $167.00 a month for her personal allowance. What can we legally spend the money on?

You better spend something. This goes against the 2k she is allowed. I am surprised she gets so much, Buy flowers once a week. I know the home looses clothing, buy more. Bring her her favorite meal. You can get her hair done. Throw a birthday party. In Moms NH they had take out night and used residents PNA to pay for the food. Ask Administration if it can be lowered and can it be used to offset her care. My Mom didn't use her $50 a month. She had everything and she was not capable of going on outings. She was on Medicaid for five months and accumulated $200 which I was allowed to receive as part of her estate.

Sweets

I think you can pay for pre-funeral arrangements if not done yet.
here is a question/post  about that
https://www.agingcare.com/questions/does-anyone-know-the-limit-medicaid-allows-for-prepaid-funeral-arrangements-440358.htm

PJs, slippers, manicure, flowers, stationery and stamps (if she can use them),

Haircuts. Toiletries. Treats. A nicer wheelchair.