Does your mil see you as your step sons Mother? Would it help to remove the step and say 'I am his Mummy, he is my son!'. You are his Mother, there is a huge difference between a step-son who spend 50% of the time with his Mum and 50% of the time with his Dad and your Ss who now has a Mummy and a Daddy. Have you adopted your Ss? I imagine as the only other women in your dh's life, MIL felt like Mummy to your Ss for those first fourteen months. In fact it seems to me that she is slipping right back into the Mummy role, which she can do as long as you identify as step mother. Where as if you claim the role of Mummy there is no need for another Mummy.
I imagine her depression masks her disappointment that she is being placed into the Granny role (justifiably). I imagine she never thought your dh would find a wife within fourteen months.
Could your dh have a word? Something along the lines of 'Mum it is really important for ds to know his boundaries, this works for us here and we need you to be on board. D's has attachment issues because of birth Mum and he really needs boundaries, structure and consistency to feel safe. Without them he is not a happy child and we really need you on board to support us. '
Involve her and have him reassure her that he is not questioning her methods, he is doing his best to support a very confused little boy.
I would also look into attachment disorders/ issues as whilst your Ss has had his Daddy from the start, he will still feel the loss of his birth Mother. My Father was adopted by my Gran when he was eighteen months old and she married my grandfather (biological father). My Dads birth Mother was a waste of space, who spent all her time drinking whilst leaving my infant father at home in a cot soaked with urine. My Gran was always my Dads Mother, never stepmother and she was a fantastic Mother and they had a wonderful bond.
There is not room for two Mummies in your ss's life, he needs to know that you are Mummy and that Granny is Granny. You need to be able to bond with your Ss, without interruption from Granny, would she cope if say you had a month of just the three of you? Your dh can obviously contact her by phone, would you be able to fit your hours around your ds's nursery? I just think that as long as Granny Mummy is visiting your house, your D's will be reverting to how things were before you arrived on the scene.
I would honestly treat this situation as though your ds has been adopted. Imagine you had adopted Ss and yet his foster parents (who had him from birth) were continuing to visit regularly. As a result your D's was regressing and he was not bonding with you as his adoptive Mother. I would say stop her visiting the house for as long as possible, then slowly reintegrate her back into his life in the role of Granny, where you visit her house. You might need to spend six months or a year doing this, once your D's feels more securely attached to you, your MIL should be able to visit without the regression.