Although the function of the adult olfactory system has been thoroughly studied, the molecular mechanisms regulating the initial formation of the olfactory nerve, the first cranial nerve, remain poorly defined. Here, we provide evidence that both modulated Notch and bone morphogenetic protein (BMP) signaling affect the generation of neurons in the olfactory epithelium and reduce the number of migratory neurons, so called epithelioid cells. We show that this reduction of epithelial and migratory neurons is followed by a subsequent failure or complete absence of olfactory nerve formation. These data provide new insights into the early generation of neurons in the olfactory epithelium and the initial formation of the olfactory nerve tract. Our results present a novel mechanism in which BMP signals negatively affect Notch activity in a dominant manner in the olfactory epithelium, thereby regulating neurogenesis and explain why a balance of BMP and Notch activity is critical for the generation of neurons and proper development of the olfactory nerve.