Establishment of the functional pulmonary vasculature requires intimate interaction between the epithelium and mesenchyme. Previous genetic studies have led to inconsistent conclusions about the contribution of epithelial Wnts to pulmonary vasculature development. This discrepancy is possibly due to the functional redundancy among different Wnts. Here, we use Shh-Cre to conditionally delete Gpr177 (the mouse ortholog of Drosophila Wntless, Wls), a chaperon protein important for the sorting and secretion of Wnt proteins. Deletion of epithelial Gpr177 reduces Wnt signaling activity in both the epithelium and mesenchyme, resulting in severe hemorrhage and abnormal vasculature, accompanied by branching defects and abnormal epithelial differentiation. We then used multiple mouse models to demonstrate that Wnt/β-catenin signaling is not only required for the proliferation and differentiation of mesenchyme, but also is important for the maintenance of smooth muscle cells through the regulation of the transcription factor Kruppel-like factor 2 (Klf2). Together, our studies define a novel mechanism by which epithelial Wnts regulate the normal development and maintenance of pulmonary vasculature. These findings provide insight into the pathobiology of congenital lung diseases, such as alveolar capillary dysplasia (ACD), that have abnormal alveolar development and dysmorphic pulmonary vasculature.