The aim of this study was to explore how some temperamentally inhibited young children and not others in the general population develop anxiety disorders and broader clinical-level internalizing (anxious/depressive) problems, with a focus on the family. A brief screening tool for inhibition was universally distributed to parents of children in their year before starting school across eight socioeconomically diverse government areas in Melbourne, Australia (307 preschool services). Screening identified 11% of all children as inhibited. We invited all parents of inhibited children to participate in a longitudinal prevention study. Participants were 545 parents of inhibited pre-schoolers (78% uptake) of whom 498 (91%) completed assessment one year later and 469 (86%) two years later. Parents completed questionnaires to assess parenting practices, parent wellbeing, and child internalizing problems. Parents also engaged in structured diagnostic interviews to assess child anxiety disorders. During the follow up period close to half of the inhibited young children had anxiety disorders and one in seven had clinical-level internalizing problems, with girls perhaps at higher risk. The family variables significantly predicted inhibited children's anxiety disorders and broader internalizing problems. For child anxiety disorders, overinvolved/protective parenting was particularly important for girls and boys, and poorer parent wellbeing contributed. For child anxious/depressive problems, harsh discipline was a consistent predictor for girls and boys, and poorer parent wellbeing again contributed. These etiological findings support early intervention for temperamentally inhibited young children that focuses on the family environment to prevent the development of mental health problems.