The ability of mesenchymal stem cells (MSC) to suppress alloresponsiveness is poorly understood. Herein, an allogeneic mixed lymphocyte response was used as a model to investigate the mechanisms of MSC-mediated immunomodulation. Human MSC are demonstrated to express the immunosuppressive cytokines hepatocyte growth factor (HGF), interleukin (IL)-10 and transforming growth factor (TGF)-beta1 at concentrations that suppress alloresponses in vitro. MSC also express cyclooxygenase 1 and 2 and produce prostaglandin E2 constitutively. Blocking studies with indomethacin confirmed that prostaglandins contribute to MSC-mediated allosuppression. The proinflammatory cytokine interferon (IFN)-gamma did not ablate MSC inhibition of alloantigen-driven proliferation but up-regulated HGF and TGF-beta1. IFN-gamma also induced expression of indoleamine 2,3, dioxygenase (IDO), involved in tryptophan catabolism. Use of an antagonist, 1-methyl-L-tryptophan, restored alloresponsiveness and confirmed an IDO contribution to IFN-gamma-induced immunomodulation by MSC. Addition of the tryptophan catabolite kynurenine to mixed lymphocyte reactions (MLR), blocked alloproliferation. These findings support a model where IDO exerts its effect through the local accumulation of tryptophan metabolites rather than through tryptophan depletion. Taken together, these data demonstrate that soluble factors, or products derived from MSC, modulate immune responses and suggest that MSC create an immunosuppressive microenvironment capable of modulating alloresponsiveness even in the presence of IFN-gamma.