Transforming growth factor (TGF)-beta mediates hypoxia-induced inhibition of alveolar development in the newborn lung. TGF-beta is regulated primarily at the level of activation of latent TGF-beta. Fibroblasts expressing Thy-1 (CD90) inhibit TGF-beta activation. We hypothesized that loss of Thy-1 due to hypoxia may be a mechanism by which hypoxia increases TGF-beta activation and that animals deficient in Thy-1 will simulate the effects of hypoxia on lung development. To determine if loss of Thy-1 occurred during hypoxia, non-transgenic (C57BL/6) wild-type (WT) mice exposed to hypoxia were evaluated for Thy-1 mRNA and protein. To determine if Thy-1 deficiency simulated hypoxia, WT and Thy-1 null (Thy-1(-/-)) mice were exposed to air or hypoxia from birth to 2 wk, the critical period of lung development, and lung histology, function, parameters related to TGF-beta signaling, and extracellular matrix protein content were measured. To test if the phenotype in Thy-1(-/-) mice was due to excessive TGF-beta signaling, measurements were also performed in Thy-1(-/-) mice administered TGF-beta neutralizing antibody (1D11). We observed that hypoxia reduced Thy-1 mRNA and Thy-1 staining in WT mice. Thy-1(-/-) mice had impaired alveolarization, increased TGF-beta signaling, reduced lung epithelial and endothelial cell proliferation but increased fibroblast proliferation, and increased collagen and elastin. Lung compliance was lower, and tissue but not airway resistance was higher in Thy-1(-/-) mice at 2 wk. Thy-1(-/-) mice given 1D11 had improved alveolar development and lung function. These data support the hypothesis that hypoxia, by reducing Thy-1, increases TGF-beta activation, and thereby inhibits normal alveolar development.