Merkel's Union bloc and the Social Democrats signed their deal to form a "grand coalition" of Germany's biggest parties after a final round of talks capped weeks of wrangling following Sept. 22 elections.
A potentially tricky hurdle still remains before Merkel can be sworn in for a third term: the Social Democrats are putting the agreement to a ballot of their roughly 470,000 members, some of whom are deeply skeptical about going into government with the chancellor. The result is expected Dec. 14.
"The spirit of this agreement is that we are a grand coalition to master grand tasks for Germany," Merkel told reporters, identifying the main priorities as "solid finances, secure prosperity and social security."
The new government will increase spending but, at the conservatives' insistence, pledged to not raise taxes and to stop running up new debts during its four-year term.
The additional spending is unlikely to satisfy critics abroad, who say Germany needs to rebalance its export-oriented economy by encouraging consumer spending. International economists say that by increasing domestic spending on imports, Germany can help other, weaker members of the 17-country eurozone — an argument Berlin has flatly rejected.
The Social Democrats secured key demands such as the introduction of a mandatory national minimum wage, which Germany is unusual among rich industrial powers in lacking. The 8.50-euro ($11.50) hourly minimum is to be introduced in 2015, though exceptions will be possible for the first two years.
Both sides secured potentially expensive changes to the pension system. The centre-left wanted to allow some workers to retire early on full pensions, and the conservatives sought higher pensions for mothers who stayed home rather than working.
In a change championed by the Social Democrats, people born in Germany who also hold a passport from a non-European Union country will no longer have to choose one citizenship — something that will apply largely to the children of Turkish immigrants.
"For them, it will be a great signal that we're saying, 'you belong to us and we don't want to build artificial obstacles,'" Social Democrat leader Sigmar Gabriel said.
Merkel has pushed other European countries to get their budgets in order during the continent's debt crisis and objected to pooling Germany's debt with that of weaker countries.
On Wednesday, she made clear she was sticking to that line, declaring that "solid finances mean, for our common Europe, placing value on having not a debt union but a stability union."
The Social Democrats have voted in the past for Merkel's crisis policies but, before the election, advocated a European debt-redemption fund. They dropped that demand; the coalition deal makes clear that the new government opposes pooling debt or pooling bank countries' deposit insurance funds.
Merkel's Union bloc finished first in the Sept. 22 elections but her partners in Germany's centre-right government of the past four years, the pro-business Free Democrats, lost all their seats in parliament. Her conservatives, meanwhile, fell short of a majority to govern alone.
That left her reaching across the aisle for a new coalition partner, leading to lengthy negotiations with the Social Democrats, who were her junior partners in her first term from 2005 to 2009.
The "grand coalition," while popular among voters, is disliked by party activists — and the Social Democrats suffered a heavy electoral defeat in 2009 after governing with Merkel. The party finished a distant second in this year's vote, and Gabriel will have to work hard to bring members on board.
"The coalition agreement is one for ... ordinary and hard-working people," he said. "A lot of things are set out here that should improve Germany's economic but also social development."
The parties won't determine who gets what job in the new government until the Social Democrats have completed their membership ballot.
In the meantime, Merkel's second-term government remains in office on a caretaker basis.