In rice panicle development, new meristems are generated sequentially in an organized manner and acquire their identity in a time- and position-dependent manner. In the panicle of the panicle phytomer2-1 (pap2-1) mutant, the pattern of meristem initiation is disorganized and newly formed meristems show reduced competency to become spikelet meristems, resulting in the transformation of early arising spikelets into rachis branches. In addition, rudimentary glumes and sterile lemmas, the outermost organs of the spikelet, elongate into a leafy morphology. We propose that PAP2 is a positive regulator of spikelet meristem identity. Map-based cloning revealed that PAP2 encodes OsMADS34, a member of the SEPALLATA (SEP) subfamily of MADS-box proteins. PAP2/OsMADS34 belongs to the LOFSEP subgroup of MADS-box genes that show grass-specific diversification caused by gene duplication events. All five SEP subfamily genes in rice are expressed exclusively during panicle development, while their spatial and temporal expression patterns vary. PAP2 expression starts the earliest among the five SEP genes, and a low but significant level of PAP2 mRNA was detected in the inflorescence meristem, in branch meristems immediately after the transition, and in glume primordia, consistent with its role in the early development of spikelet formation. Our study provides new evidence supporting the hypothesis that the genes of the LOFSEP subgroup control developmental processes that are unique to grass species.