Mesenchymal stem cells (MSCs; also referred to as mesenchymal stromal cells) have attracted much attention for their ability to regulate inflammatory processes. Their therapeutic potential is currently being investigated in various degenerative and inflammatory disorders such as Crohn's disease, graft-versus-host disease, diabetic nephropathy and organ fibrosis. The mechanisms by which MSCs exert their therapeutic effects are multifaceted, but in general, these cells are thought to enable damaged tissues to form a balanced inflammatory and regenerative microenvironment in the presence of vigorous inflammation. Studies over the past few years have demonstrated that when exposed to an inflammatory environment, MSCs can orchestrate local and systemic innate and adaptive immune responses through the release of various mediators, including immunosuppressive molecules, growth factors, exosomes, chemokines, complement components and various metabolites. Interestingly, even nonviable MSCs can exert beneficial effects, with apoptotic MSCs showing immunosuppressive functions in vivo. Because the immunomodulatory capabilities of MSCs are not constitutive but rather are licensed by inflammatory cytokines, the net outcomes of MSC activation might vary depending on the levels and the types of inflammation within the residing tissues. Here, we review current understanding of the immunomodulatory mechanisms of MSCs and the issues related to their therapeutic applications.