GWAS have repeatedly mapped susceptibility loci for emphysema to genes that modify hedgehog signaling, but the functional relevance of hedgehog signaling to this morbid disease remains unclear. In the current study, we identified a broad population of mesenchymal cells in the adult murine lung receptive to hedgehog signaling, characterized by higher activation of hedgehog surrounding the proximal airway relative to the distal alveoli. Single-cell RNA-sequencing showed that the hedgehog-receptive mesenchyme is composed of mostly fibroblasts with distinct proximal and distal subsets with discrete identities. Ectopic hedgehog activation in the distal fibroblasts promoted expression of proximal fibroblast markers and loss of distal alveoli and airspace enlargement of over 20% compared with controls. We found that hedgehog suppressed mesenchymal-derived mitogens enriched in distal fibroblasts that regulate alveolar stem cell regeneration and airspace size. Finally, single-cell analysis of the human lung mesenchyme showed that segregated proximal-distal identity with preferential hedgehog activation in the proximal fibroblasts was conserved between mice and humans. In conclusion, we showed that differential hedgehog activation segregates mesenchymal identities of distinct fibroblast subsets and that disruption of fibroblast identity can alter the alveolar stem cell niche, leading to emphysematous changes in the murine lung.