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Bronchopulmonary dysplasia is a common pulmonary complication of extreme prematurity. Arrested lung development leads to bronchopulmonary dysplasia, but the molecular pathways that cause this arrest are unclear. Lung injury and inflammation increase disease risk, but the cellular site of the inflammatory response and the potential role of localized inflammatory signaling in inhibiting lung morphogenesis are not known. In this study, we show that tissue macrophages present in the fetal mouse lung mediate the inflammatory response to LPS and that macrophage activation inhibits airway morphogenesis. Macrophage depletion or targeted inactivation of the NF-κB signaling pathway protected airway branching in cultured lung explants from the effects of LPS. Macrophages also appear to be the primary cellular site of IL-1β production following LPS exposure. Conversely, targeted NF-κB activation in transgenic macrophages was sufficient to inhibit airway morphogenesis. Macrophage activation in vivo inhibited expression of multiple genes critical for normal lung development, leading to thickened lung interstitium, reduced airway branching, and perinatal death. We propose that fetal lung macrophage activation contributes to bronchopulmonary dysplasia by generating a localized inflammatory response that disrupts developmental signals critical for lung formation.