Diffusion MRI has been successful in identifying the existence of white matter abnormalities in schizophrenia in vivo. However, the role of these abnormalities in the etiology of schizophrenia is not well understood. Accumulating evidence from imaging, histological, genetic, and immunochemical studies support the involvement of axonal degeneration and neuroinflammation--ubiquitous components of neurodegenerative disorders--as the underlying pathologies of these abnormalities. Nevertheless, the current imaging modalities cannot distinguish neuroinflammation from axonal degeneration, and therefore provide little specificity with respect to the pathophysiology progression and whether it is related to a neurodegenerative process. Free-water imaging is a new methodology that is sensitive to water molecules diffusing in the extracellular space. Excessive extracellular volume is a surrogate biomarker for neuroinflammation and can be separated out to reveal abnormalities such as axonal degeneration that affect diffusion characteristics in the tissue. We applied free-water imaging on diffusion MRI data acquired from schizophrenia-diagnosed human subjects with a first psychotic episode. We found a significant increase in the extracellular volume in both white and gray matter. In contrast, significant signs of axonal degeneration were limited to focal areas in the frontal lobe white matter. Our findings demonstrate that neuroinflammation is more prominent than axonal degeneration in the early stage of schizophrenia, revealing a pattern shared by many neurodegenerative disorders, in which prolonged inflammation leads to axonal degeneration. These findings promote anti-inflammatory treatment for early diagnosed schizophrenia patients.