Barring an unlikely escalation into a wider war with Syria, how does Israel decide when and how to stop the retaliation? The most likely outcome, I think, will be what certain conservatives will call a "war of half-measures," since the alternatives can get rapidly messy. They'll continue for one or two weeks, shelling the hell out any Hezbollah target they can find until they're convinced that they've exacted a heavy enough toll to dissuade further attacks. Once Israel feels she has bloodied Lebanon sufficiently, they'll declare victory in cease-fire form and go home.
The real question is whether or not they'll engage in a ground assault. I think they probably should, so long as they keep their heads about them by not allowing a sustained occupation. Air power, of course, has never won a war. If you want to kill the bad guys instead of innocents you have to do it on the ground, fighting as men. You have to put your soldiers in harm's way rather than cowardly dropping bombs on apartment complexes, radicalizing a whole new generation through deaths of innocents, creation of hundreds of thousands of refugees, and billions of dollars of damage done to civilian infrastructure.
Of course, the Israelis shouldn't call it an invasion. Rather, a ground assault would have to be a targeted incursion designed to suppress the Hezbollah enemy in a buffer zone roughly the size of the Katyusha rocket's range - 12 miles or so - since the Katyusha is the dominant armament Hezbollah possesses. Luckily, those are truck mounted systems, so the Israelis wont have to search the basements of all those apartment buildings they keep blowing up in order to fight the enemy. The IDF couldn't win that fight in the traditional sense. Instead of battling through the warrens of Lebanon taking heavy casualties, the IDF would just destroy any Hezbollah military infrastructure on the ground and as many of those Katyusha launchers as possible. Effectively, Israel would be seeking to establish a DMZ on its border to remove the umbrella of threat they live under. The Israelis can easily justify this action, going so far as to cast it as giving assistance to the Lebanese government to conform to U.N. resolution 1559. "Since you can't maintain control over your country, we'll disarm Hezbollah for you, then leave immediately and some one else will be responsible for keeping the D in DMZ."
While that action is justified, it may not be so easy. Can they achieve those goals without an occupation (which is a strategic loss)? If they were to invade Southern Lebanon - Hezbollah's stronghold - they would meet stand-up resistance that they could easily defeat. The resistance will not stay so direct, however. Hezbollah should be expected to adroitly turn to insurgent tactics, harassing the Israelis from their tunnels, making it easier for them to sustain the fight and harder for Israel to leave. No one likes leaving an engagement while still under fire, after all. That feels too much like retreat, and Olmert has never served in the military. Plus, no peacekeeping force will insert until there is an actual peace to keep, and those troops wouldn't be easy to find under the best conditions. That leaves the Lebanese Army, which hopefully, after the pain inflicted on Hezbollah, will be strong enough to reestablish the government's sovereignty over its southern reaches.
What will this accomplish in terms of actually dissuading further violence against Israel? I wonder what history would tell us... oh, right.