When regenerative processes cannot keep pace with cell death, functional epithelia are replaced by scar. Scarring is characterized by both excessive accumulation of fibrous matrix and persistent outgrowth of cell types that accumulate transiently during successful wound healing, including myofibroblasts (MFs) and progenitors. This suggests that signaling that normally directs these cells to repair injured epithelia is deregulated. To evaluate this possibility, we examined liver repair during different types of liver injury after Smoothened (SMO), an obligate intermediate in the Hedgehog (Hh) signaling pathway, was conditionally deleted in cells expressing the MF-associated gene, αSMA. Surprisingly, blocking canonical Hh signaling in MFs not only inhibited liver fibrosis but also prevented accumulation of liver progenitors. Hh-sensitive, hepatic stellate cells (HSCs) were identified as the source of both MFs and progenitors by lineage-tracing studies in 3 other strains of mice, coupled with analysis of highly pure HSC preparations using flow cytometry, immunofluorescence confocal microscopy, RT-PCR, and in situ hybridization. The results identify SMO as a master regulator of hepatic epithelial regeneration based on its ability to promote mesenchymal-to-epithelial transitions in a subpopulation of HSC-derived MFs with features of multipotent progenitors.