The balance between type 1 and 2 T helper cell cytokine production plays an important role in several animal models of autoimmunity, and skewed patterns of cytokine expression have been described in human inflammatory diseases. Many cytokines activate signal transducer and activation of transcription (STAT) transcription factors, which, in turn, activate transcription of inflammatory effector genes. We used mononuclear cell priming cultures and inflammatory synovial fluids (SFs) derived from arthritis patients to examine the regulation of cytokine production and STAT activity by an inflammatory synovial microenvironment. Exposure to SFs during priming resulted in an 81% inhibition of interferon (IFN)-gamma, but not interleukin (IL) 4, production by effector cells generated in priming cultures. SF suppression was mediated by IL-4 and IL-10 and inhibition of IL-12 expression, and it was reversed in a dominant fashion by exogenous IL-12. SFs blocked the sustained activity of transcription factor Stat1, but not Stat3, during the priming period, and Stat1 activity was differentially regulated by cytokines in parallel with their positive or negative regulation of IFN-gamma production. Active Stat3, but not Stat1, was detected in cells from inflamed joints. These results suggest a role for altered balance of Stat1 and Stat3 transcriptional activity in the regulation of T cell differentiation and in the pathogenesis of inflammatory synovitis.