Bone marrow-derived mesenchymal stem cells (MSCs) sustain cancer cells by creating a microenvironment favorable for tumor growth. In particular, MSCs have been implicated in gastric cancer development. There is extensive evidence suggesting that Hedgehog signaling regulates tumor growth. However, very little is known regarding the precise roles of Hedgehog signaling and MSCs in tumor development within the stomach. The current study tests that hypothesis that Shh, secreted from MSCs, provides a proliferative stimulus for the gastric epithelium in the presence of inflammation. RFP-expressing MSCs transformed in vitro (stMSCs) were transduced with lentiviral constructs containing a vector control (stMSC^vect) or shRNA targeting the Shh gene (stMSC^ShhKO). Gastric submucosal transplantation of wild type MSCs (wtMSCs), wild type MSCs over-expressing Shh (wtMSC^Shh), stMSC^vect or stMSC^ShhKO cells in C57BL/6 control (BL/6) or gastrin-deficient (GKO) mice was performed and mice analyzed 30 and 60 days post-transplantation. Compared to BL/6 mice transplanted with wtMSC^Shh and stMSC^vect cells, inflamed GKO mice developed aggressive gastric tumors. Tumor development was not observed in mouse stomachs transplanted with wtMSC or stMSC^ShhKO cells. Compared to stMSC^ShhKO transplanted mice, within the inflamed GKO mouse stomach Shh-expressing stMSCs^vect and wtMSCs^Shh induced proliferation of CD44-positive cells. CD44-positive cells clustered in gland-like structures within the tumor stroma and were positive for Ptch expression. We conclude that Shh, secreted from MSCs, provides a proliferative stimulus for the gastric epithelium that is associated with tumor development, a response that is sustained by chronic inflammation.