Dentate gyrus and hippocampus as centers for spatial learning, memory and emotional behaviour have been the focus of much interest in recent years. The molecular information on its development, however, has been relatively poor. To date, only Emx genes were known to be required for dorsal telencephalon development. Here, we report on forebrain development in the extra toes (Xt(J)) mouse mutant which carries a null mutation of the Gli3 gene. This defect leads to a failure to establish the dorsal di-telencephalic junction and finally results in a severe size reduction of the neocortex. In addition, Xt(J)/Xt(J) mice show absence of the hippocampus (Ammon's horn plus dentate gyrus) and the choroid plexus in the lateral ventricle. The medial wall of the telencephalon, which gives rise to these structures, fails to invaginate during embryonic development. On a molecular level, disruption of dorsal telencephalon development in Xt(J)/Xt(J) embryos correlates with a loss of Emx1 and Emx2 expression. Furthermore, the expression of Fgf8 and Bmp4 in the dorsal midline of the telencephalon is altered. However, expression of Shh, which is negatively regulated by Gli3 in the spinal cord, is not affected in the Xt(J)/Xt(J) forebrain. This study therefore implicates Gli3 as a key regulator for the development of the dorsal telencephalon and implies Gli3 to be upstream of Emx genes in a genetic cascade controlling dorsal telencephalic development.