Sonic hedgehog (Shh) is a morphogenic protein that operates through the Gli transcription factor-dependent canonical pathway to orchestrate normal development of many tissues. Because aberrant levels of Gli activity lead to a wide spectrum of diseases ranging from neurodevelopmental defects to cancer, understanding the regulatory mechanisms of Shh canonical pathway is paramount. During early stages of spinal cord development, Shh specifies neural progenitors through the canonical signaling. Despite persistence of Shh as spinal cord development progresses, Gli activity is switched off by unknown mechanisms. In this study we find that Shh inverts its action on Gli during development. Strikingly, Shh decreases Gli signaling in the embryonic spinal cord by an electrical activity- and cAMP-dependent protein kinase-mediated pathway. The inhibition of Gli activity by Shh operates at multiple levels. Shh promotes cytosolic over nuclear localization of Gli2, induces Gli2 and Gli3 processing into repressor forms, and activates cAMP-responsive element binding protein that in turn represses gli1 transcription. The regulatory mechanisms identified in this study likely operate with different spatiotemporal resolution and ensure effective down-regulation of the canonical Shh signaling as spinal cord development progresses. The developmentally regulated intercalation of electrical activity in the Shh pathway may represent a paradigm for switching from canonical to noncanonical roles of developmental cues during neuronal differentiation and maturation.