Previous studies have suggested that defects in pancreatic epithelium caused by activation of the Hedgehog (Hh) signaling pathway are secondary to changes in the differentiation state of the surrounding mesenchyme. However, recent results describe a role of the pathway in pancreatic epithelium, both during development and in adult tissue during neoplastic transformation. To determine the consequences of epithelial Hh activation during pancreas development, we employed a transgenic mouse model in which an activated version of GLI2, a transcriptional mediator of the pathway, is overexpressed specifically in the pancreatic epithelium. Surprisingly, efficient Hh activation was not observed in these transgenic mice, indicating the presence of physiological mechanisms within pancreas epithelium that prevent full Hh activation. Additional studies revealed that primary cilia regulate the level of Hh activation, and that ablation of these cellular organelles is sufficient to cause significant up-regulation of the Hh pathway in pancreata of mice overexpressing GLI2. As a consequence of overt Hh activation, we observe profound morphological changes in both the exocrine and endocrine pancreas. Increased Hh activity also induced the expansion of an undifferentiated cell population expressing progenitor markers. Thus, our findings suggest that Hh signaling plays a critical role in regulating pancreatic epithelial plasticity.