Phencyclidine (PCP) is a psychotomimetic drug that induces schizophrenia-like symptoms in healthy individuals and exacerbates pre-existing symptoms in patients with schizophrenia. PCP also induces behavioral and cognitive abnormalities in non-human animals, and PCP-treated animals are considered a reliable pharmacological model of schizophrenia. However, the exact neural mechanisms by which PCP modulates behavior are not known. During the last decade several studies have indicated that disturbed activity of the prefrontal cortex (PFC) may be closely related to PCP-induced psychosis. Systemic administration of PCP produces long-lasting activation of medial PFC (mPFC) neurons in rats, almost in parallel with augmentation of locomotor activity and behavioral stereotypies. Later studies have showed that such PCP-induced behavioral abnormalities are ameliorated by prior administration of drugs that normalize or inhibit excess excitability of PFC neurons. Similar activation of mPFC neurons is not induced by systemic injection of a typical psychostimulant such as methamphetamine, even though behavioral hyperactivity is induced to almost the same level. This suggests that the neural circuits mediating PCP-induced psychosis are different to those mediating methamphetamine-induced psychosis. Locally applied PCP does not induce excitation of mPFC neurons, indicating that PCP-induced tonic excitation of mPFC neurons is mediated by inputs from regions outside the mPFC. This hypothesis is strongly supported by experimental results showing that local perfusion of PCP in the ventral hippocampus, which has dense fiber projections to the mPFC, induces tonic activation of mPFC neurons with accompanying augmentation of behavioral abnormalities. In this review we summarize current knowledge on the neural mechanisms underlying PCP-induced psychosis and highlight a possible involvement of the PFC and the hippocampus in PCP-induced psychosis.