Fibroblast growth factor (FGF) signaling has been shown to regulate lung epithelial development but its influence on mesenchymal differentiation has been poorly investigated. To study the role of mesenchymal FGF signaling in the differentiation of the mesenchyme and its impact on epithelial morphogenesis, we took advantage of Fgfr2c^+/Δ mice, which due to a splicing switch express Fgfr2b in mesenchymal tissues and manifest Apert syndrome-like phenotypes. Using a set of in vivo and in vitro studies, we show that an autocrine FGF10–FGFR2b signaling loop is established in the mutant lung mesenchyme, which has several consequences. It prevents the entry of the smooth muscle progenitors into the smooth muscle cell (SMC) lineage and results in reduced fibronectin and elastin deposition. Levels of Fgf10 expression are raised within the mutant mesenchyme itself. Epithelial branching as well as epithelial levels of FGF and canonical Wnt signaling is dramatically reduced. These defects result in arrested development of terminal airways and an “emphysema like” phenotype in postnatal lungs. Our work unravels part of the complex interactions that govern normal lung development and may be pertinent to understanding the basis of respiratory defects in Apert syndrome.