The lung’s gas exchange surface is comprised of alveolar AT1 and AT2 cells that are corrupted in several common and deadly diseases. They arise from a bipotent progenitor whose differentiation is thought to be dictated by differential mechanical forces. Here we show the critical determinant is FGF signaling. Fgfr2 is expressed in the developing progenitors in mouse then restricts to nascent AT2 cells and remains on throughout life. Its ligands are expressed in surrounding mesenchyme and can, in the absence of exogenous mechanical cues, induce progenitors to form alveolospheres with intermingled AT2 and AT1 cells. FGF signaling directly and cell autonomously specifies AT2 fate; progenitors lacking Fgfr2 in vitro and in vivo exclusively acquire AT1 fate. Fgfr2 loss in AT2 cells perinatally results in reprogramming to AT1 identity, whereas loss or inhibition later in life triggers AT2 apoptosis and compensatory regeneration. We propose that Fgfr2 signaling selects AT2 fate during development, induces a cell non-autonomous AT1 differentiation signal, then continuously maintains AT2 identity and survival throughout life.