Severe lung injury causes airway basal stem cells to migrate and outcompete alveolar stem cells, resulting in dysplastic repair. We found that this "stem cell collision" generates an injury-induced tissue niche containing keratin 5+ epithelial cells and plastic Pdgfra+ mesenchymal cells. Single-cell analysis revealed that the injury-induced niche is governed by mesenchymal proliferation and Notch signaling, which suppressed Wnt/Fgf signaling in the injured niche. Conversely, loss of Notch signaling rewired alveolar signaling patterns to promote functional regeneration and gas exchange. Signaling patterns in injury-induced niches can differentiate fibrotic from degenerative human lung diseases through altering the direction of Wnt/Fgf signaling. Thus, we have identified an injury-induced niche in the lung with the ability to discriminate human lung disease phenotypes.