Pulmonary infection is the most common risk factor for acute lung injury (ALI). Innate immune responses induced by Microbe-Associated Molecular Pattern (MAMP) molecules are essential for lung defense but can lead to tissue injury. Little is known about how MAMP molecules are degraded in the lung or how MAMP degradation/inactivation helps prevent or ameliorate the harmful inflammation that produces ALI. Acyloxyacyl hydrolase (AOAH) is a host lipase that inactivates Gram-negative bacterial endotoxin (lipopolysaccharide, or LPS). We report here that alveolar macrophages increase AOAH expression upon exposure to LPS and that Aoah+/+ mice recover more rapidly than do Aoah-/- mice from ALI induced by nasally instilled LPS or Klebsiella pneumoniae. Aoah-/- mouse lungs had more prolonged leukocyte infiltration, greater pro- and anti-inflammatory cytokine expression, and longer-lasting alveolar barrier damage. We also describe evidence that the persistently bioactive LPS in Aoah-/- alveoli can stimulate alveolar macrophages directly and epithelial cells indirectly to produce chemoattractants that recruit neutrophils to the lung and may prevent their clearance. Distinct from the prolonged tolerance observed in LPS-exposed Aoah-/- peritoneal macrophages, alveolar macrophages that lacked AOAH maintained or increased their responses to bioactive LPS and sustained inflammation. Inactivation of LPS by AOAH is a previously unappreciated mechanism for promoting resolution of pulmonary inflammation/injury induced by Gram-negative bacterial infection.