The Hedgehog (Hh) pathway has been implicated in pancreatic cancer but its role remains controversial. To delineate the cell populations able to respond to Hh ligand stimulation, we expressed an oncogenic allele of Smoothened (SmoM2) to cell autonomously activate Hh signaling in the mouse pancreas. Surprisingly, we found that expression of SmoM2 in epithelial cells was not able to activate the pathway and had no impact on pancreatic development or neoplasia. In contrast, activation of Smo in the mesenchyme led to Hh pathway activation, indicating that only the tumor stroma is competent to transduce the Hh signal. Using a Ptc-LacZ reporter mouse, we show that Hh signaling is active in stromal cells surrounding Hh-expressing tumor epithelium in various mouse pancreatic cancer models. Activation of the Hh pathway in the tumor stroma of human pancreatic and metastatic cancer specimens was confirmed by quantitative RT-PCR of microdissected tissue samples. These data support a paracrine model of Hh-mediated tumorigenesis, in which tumor cells secrete Hh ligand to induce tumor-promoting Hh target genes in adjacent stroma.