The move clears five officers who had been accused over the botched raid by F-16 jets near Uludere in south-eastern Turkey. Those involved had "made an unavoidable mistake", prosecutors said.
Kurdish groups condemned the ruling.
In December 2011 Turkey expressed regret over the raid, saying smugglers had been mistaken for Kurdish rebels.
Ferhat Encu, who lost two brothers and nine other relatives in the raid, said "the killer state has been acquitted once again", the Turkish daily Hurriyet reported on its website.
Last November the European Court of Human Rights ruled against Turkey over a similar air strike that took place in 1994. In that incident, 38 Kurdish villagers died in Sirnak province, near the Iraqi border.
Uludere is in the same province, an area where armed Kurdistan Workers' Party (PKK) rebels are particularly active. The rebels have been fighting for an independent state since 1984.
The European court in Strasbourg ordered Turkey to pay 2.3m euros (£2m; $3m) to the plaintiffs, saying the authorities had failed to investigate the raid properly.
The military prosecutors' statement on Tuesday said the December 2011 air strike had been approved by the Turkish General Staff.
"The army personnel made an unavoidable mistake while performing their duties," the prosecutors said.
A lawyer representing the families of victims, Tahir Elci, denounced the ruling. He said the plaintiffs would lodge an appeal with Turkey's Constitutional Court, the AFP news agency reported.
Turkey is currently gripped by political tensions in the ruling AK Party, which also affect scores of military officers convicted over alleged coup plots. Prime Minister Recep Tayyip Erdogan has backed calls for retrials in the high-profile "coup" investigations.
Turkish military prosecutors have dropped an investigation into the deaths of 34 Kurdish civilians in an air force bombing raid in 2011.