McDonald has spent the last four years at West Ham working as assistant manager to Sam Allardyce.
The 49-year-old succeeds Lee Clark who resigned in the wake of the club’s relegation to League One earlier this month.
Clark took charge of Blackpool on October 30 with the club bottom of the Championship table but managed to secure only three wins in 33 games.
McDonald, who also worked with Allardyce at Blackburn and Bolton, previously spent a year as Carlisle manager and saved Ostersunds FK from relegation during the five weeks he was in charge of the Swedish club.
“This is a great opportunity for me, it’s a massive football club in my opinion and I’m really looking forward to the challenge,” McDonald told the official website.
“It’s a challenge that’s going to be difficult – wherever you go it’s always difficult – but it’s a challenge that I’m really up for and really excited about.
“I’ve got to try and put my stamp on the football club and get it back to where it was. I’ve got to try and stabilise it first of all after what happened last year with relegation and change people’s minds to try and get the confidence back and push the club on to pastures new.”
Blackpool’s head of youth coaching Richie Kyle has been promoted to the role of first-team coach, while Paul Stephenson and Paul Crichton have left the back-room team.