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Indian hedgehog (Ihh) is indispensable for development of the osteoblast lineage in the endochondral skeleton. In order to determine whether Ihh is directly required for osteoblast differentiation, we have genetically manipulated smoothened (Smo), which encodes a transmembrane protein that is essential for transducing all Hedgehog (Hh) signals. Removal of Smo from perichondrial cells by the Cre-LoxP approach prevents formation of a normal bone collar and also abolishes development of the primary spongiosa. Analysis of chimeric embryos composed of wild-type and Smo^n/n cells indicates that Smo^n/n cells fail to contribute to osteoblasts in either the bone collar or the primary spongiosa but generate ectopic chondrocytes. In order to assess whether Ihh is sufficient to induce bone formation in vivo, we have analyzed the bone collar in the long bones of embryos in which Ihh was artificially expressed in all …