Genetic and cell biological studies have indicated that Indian hedgehog (Ihh) plays an important role in bone development and osteoblast differentiation. However, the molecular mechanism by which Ihh regulates osteoblast differentiation is complex and remains to be fully elucidated. In this study, we investigated the role of Ihh signaling in osteoblast differentiation using mesenchymal cells and primary osteoblasts. We observed that Ihh stimulated alkaline phosphatase (ALP) activity, osteocalcin expression, and calcification. Overexpression of Gli2- but not Gli3-induced ALP, osteocalcin expression, and calcification of these cells. In contrast, dominant-negative Gli2 markedly inhibited Ihh-dependent osteoblast differentiation. Ihh treatment or Gli2 overexpression also up-regulated the expression of Runx2, an essential transcription factor for osteoblastogenesis, and enhanced the transcriptional activity and osteogenic action of Runx2. Coimmunoprecipitation analysis demonstrated a physical interaction between Gli2 and Runx2. Moreover, Ihh or Gli2 overexpression failed to increase ALP activity in Runx2-deficient mesenchymal cells. Collectively, these results suggest that Ihh regulates osteoblast differentiation of mesenchymal cells through up-regulation of the expression and function of Runx2 by Gli2.