Intercellular signaling by bone morphogenetic proteins (BMPs) regulates developmental decisions in virtually all animals. Here, we report that Decapentaplegic (Dpp; a Drosophila BMP family member) plays a role in blood cell homeostasis and immune responses by regulating a transcription factor cascade. The cascade begins with Dpp repression of Zfh1, continues with Zfh1 activation of Serpent (Srp; a GATA factor), and terminates with Srp activation of U-shaped (Ush) in hematopoietic cells. Hyperactivation of Zfh1, Srp, and Ush in dpp mutants leads to hyperplasia of plasmatocytes. Salmonella challenge revealed that in dpp mutants the misregulation of this cascade also prevents the generation of lamellocytes. These findings support the hypothesis that Ush participates in a switch between plasmatocyte and lamellocyte fate in a common precursor and further suggests a mechanism for how all blood cell types can arise from a single progenitor. These results also demonstrate that combining Drosophila and Salmonella genetics can provide novel opportunities for advancing our knowledge of hematopoiesis and innate immunity.