In this study we examined the ability of interferon-gamma (IFN-gamma) to regulate mammary epithelial cell growth and gene expression, with particular emphasis on two genes: Maspin (a member of serine protease inhibitor superfamily), and the lysosomal aspartyl endopeptidase cathepsin D (CatD). The protein products of these genes are critically involved in regulation of multitude of biological functions in different stages of mammary tissue development and remodeling. In addition, the expression of Maspin is down-regulated in primary breast cancer and is lost in metastatic disease, while CatD is excessively produced and aberrantly secreted by breast cancer cells. We report that IFN-gamma receptors are expressed in mammary epithelial cells, and receptor engagement by IFN-gamma transduces the IFN-gamma signal via Stat-1 resulting in decreased vacuolar pH. This change in vacuolar pH alters CatD protein processing and secretion concurrent with increased Maspin secretion. In addition, IFN-gamma exerts a suppressive effect on cell growth and proliferation, and induces morphological changes in mammary epithelial cells. Our studies also reveal that breast cancer cells, which are devoid of Maspin, are refractory to IFN-gamma with respect to changes in vacuolar pH and CatD. However, Maspin transfection of breast cancer cells partially sensitizes the cells to IFN-gamma's effect, thus providing new therapeutic implications.