His grandfather, Oscar Hammerstein I, was an opera impresario, and his uncle was a successful Broadway producer. While a college student, the younger Hammerstein wrote and performed in several varsity shows at Columbia University. His first musical, Always You, for which he wrote the book and lyrics, opened on Broadway in 1921. He was co-writer of the popular Rudolf Friml operetta Rose-Marie, and then began a successful collaboration with composer Jerome Kern on Sunny, which was a great hit. Their most successful collaboration, though was the 1927 musical Show Boat, which is considered to be one of the masterpieces of the American musical theatre. Hammerstein continued to work with Kern and operetta composer Sigmund Romberg, among others, over the next several years on shows such as Sweet Adeline, Music in the Air, and Very Warm for May, a critical failure which nevertheless contained one of Kern and Hammerstein's loveliest songs, 'All the Things You Are.'

Hammerstein began his most successful and sustained collaboration in 1943 when he teamed up with Richard Rodgers, whose regular partner, Lorenz Hart, was uninterested in the material, to write a musical based on Lynn Riggs' play Green Grow the Lilacs. The result was Oklahoma!, a show which revolutionized the American musical theatre by focusing on a sentimentally-based Americana, rather than current issues and characters. It also began a partnership which would produce such classic Broadway musicals as Carousel, South Pacific, The King and I, Flower Drum Song, and The Sound of Music, as well as the musical film State Fair and the television musical Cinderella. Hammerstein also produced the book and lyrics for Carmen Jones, an adaptation of Georges Bizet's opera Carmen with an all-black cast.

Hammerstein died shortly after the opening of The Sound of Music on Broadway, ending one of the most remarkable collaborations in the history of the American musical theatre. Universally mourned, he was interred in the Ferncliff Cemetery in Hartsdale, New York.