As a member of the nuclear hormone receptor superfamily of ligand-activated transcription factors, the glucocorticoid receptor (GR) is essential for normal embryonic development. To date, the role of mesenchymal glucocorticoid signaling during development has not been fully elucidated. In the present study, we investigated the role of the GR during embryogenesis specifically in mesenchymal tissues. To this aim, we crossed GRflox mice with Dermo1-Cre mice to generate GR(Dermo1) mice, where the GR gene was deleted within mesenchymal cells. Compared to their wild type littermates, GR(Dermo1) mice displayed severe pulmonary atelectasis, defects in abdominal wall formation resulting in intestinal herniation, abnormal extracellular matrix synthesis in connective tissues and high postnatal lethality. Lungs of GR(Dermo1) mice failed to progress from the canalicular to saccular stage, as evidenced by the presence of immature air sacs, thickened interstitial mesenchyme and an underdeveloped vascular network between E17.5 and E18.5. Furthermore, myofibroblasts and vascular smooth muscle cells, although present in normal numbers in GR(Dermo1) animals, were characterized by significantly reduced elastin synthesis, whilst epithelial lining cells of the immature saccules were poorly differentiated. A marked reduction in normal elastin and collagen deposits were also observed in connective tissues adjacent to the umbilical hernia. This study demonstrates that eliminating the GR in cells of the mesenchymal lineage results in marked effects on interstitial fibroblast function, including a significant decrease in elastin synthesis. This results in lung atelectasis and postnatal lethality, as well as additional and hitherto unrecognized developmental defects in abdominal wall formation. In addition, altered glucocorticoid signaling in the mesenchyme attenuates normal lung epithelial differentiation.