Downing, 21, has made 40 appearances for the Saddlers since joining from West Brom in 2012 and manager Dean Smith is delighted the highly-rated youngster has put pen to paper.
"I'm really pleased that Paul has signed this new deal," he said.
"He's done really well since he broke into the team and has put in some consistent and mature displays.
"With the way he has played and developed since he has been here, he deserves it. It's important for the club and the direction in which we want to go that players like Paul are signed up on longer deals.
"He's a hard-working lad who was given an excellent grounding in the game at West Brom and has taken the chance that has been presented to him here.
"He had to be patient initially, but he's grabbed his opportunity and it's a real boost that he has committed his future to us and what we are trying to achieve here."
Downing himself added: "I'm happy the deal has been done and now I want to concentrate on the rest of the season.
"I'm happy here, I'm a local lad who is really enjoying his football and I am delighted with the progress I have made since I have been at the club.
"My improvement is a credit to the staff and players and now I want to focus on carrying that on. I'm still young and learning all of the time."