The hedgehog signal transduction network performs critical roles in mediating cell-cell interactions during embryogenesis and organogenesis. Loss-of-function or misexpression mutation of hedgehog network components can cause birth defects, skin cancer, and other tumors. The Gli gene family (Gli1, Gli2, and Gli3) encodes zinc finger transcription factors that act as mediators of hedgehog signal transduction. In this study, we investigate the role of Gli2 in mammary gland development. Mammary expression of Gli2 is developmentally regulated in a tissue compartment-specific manner. Expression is exclusively stromal during virgin stages of development but becomes both epithelial and stromal during pregnancy and lactation. The null phenotype with respect to both ductal and alveolar development was examined by transplantation rescue of embryonic mammary glands into physiologically normal host females. Glands derived from both wild type and null embryo donors showed ductal outgrowths that developed to equivalent extents in virgin hosts. However, in null transplants, ducts were frequently distended or irregularly shaped and showed a range of histological alterations similar to micropapillary ductal hyperplasias in the human breast. Alveolar development during pregnancy was not overtly affected by loss of Gli2 function. Ductal defects were not observed when homozygous null epithelium was transplanted into a wild type stromal background, indicating that Gli2 function is required primarily in the stroma for proper ductal development. DeltaGli2 heterozygotes also demonstrated an elevated frequency and severity of focal ductal dysplasia relative to that of wild type littermate- and age-matched control animals.