The embryonic diencephalon gives rise to the vertebrate thalamus and hypothalamus, which play essential roles in sensory information processing and control of physiological homeostasis and behavior, respectively. In this review, we present new steps toward characterizing the molecular pathways that control development of these structures, based on findings in a variety of model organisms. We highlight advances in understanding how early regional patterning is orchestrated through the action of secreted signaling molecules such as Sonic hedgehog and fibroblast growth factors. We address the role of individual transcription factors in control of the regional identity and neural differentiation within the developing diencephalon, emphasizing the contribution of recent large-scale gene expression studies in providing an extensive catalog of candidate regulators of hypothalamic neural cell fate specification. Finally, we evaluate the molecular mechanisms involved in the experience-dependent development of both thalamo-cortical and hypothalamic neural circuitry.