Dexamethasone is the standard of care for critically ill patients with COVID-19, but the mechanisms by which it decreases mortality and its immunological effects in this setting are not understood. We performed bulk and single-cell RNA sequencing of the lower respiratory tract and blood, and plasma cytokine profiling to study the effect of dexamethasone on systemic and pulmonary immune cells. We find decreased signatures of antigen presentation, T cell recruitment, and viral injury in patients treated with dexamethasone. We identify compartment- and cell- specific differences in the effect of dexamethasone in patients with severe COVID-19 that are reproducible in publicly available datasets. Our results highlight the importance of studying compartmentalized inflammation in critically ill patients.