The deal announced on Wednesday caps weeks of haggling between chancellor-in-waiting Merz and the SPD after he topped elections in February but fell well short of a majority, with the far-right Alternative for Germany surging into second place.
Pressure to reach a deal has taken on new urgency as the government will take charge at a time of global turbulence in an escalating trade conflict sparked by US President Donald Trump's sweeping import tariffs.
During a news conference with his coalition partners, Merz directed a message to the White House in English.
"The key message to Donald Trump is Germany is back on track," he said, promising to ramp up defence spending and boost the competitiveness of the economy.
He said the coalition pact provided a "strong and clear signal" both to its own citizens and other European countries, adding: "Germany is getting a government that is capable of action and strong."
The deal stressed the importance of Germany's relations with the United States, its largest trading partner, and aims for a free trade deal in the medium term. But Merz also emphasised that the European Union needed a common response to the escalating global tariff war that has put the US and China in particular at loggerheads.
"At the same time, economic uncertainty is increasing enormously," Merz said.
"This week in particular, decisions by the American government have triggered new turmoil."
Outlining a raft of policies, the coalition agreed to cut taxes for middle and lower incomes, to reduce corporate tax, lower energy prices, support the electric car industry and scrap a disputed supply chain law.
It also plans a commission on further reforming Germany's constitutionally enshrined spending limits known as the "debt brake", long seen by critics as hobbling economic growth.
"All of this is going in the right direction, but it is not a real restart in economic policy that would be necessary in view of the competitiveness that has been eroding for years," said Joerg Kraemer, chief economist at Commerzbank.
The parties also announced some new spending, such as restoring diesel fuel subsidies for farmers.
With the AfD breathing down its neck, the coalition signalled a tougher stance on migration, planning to turn away asylum seekers at Germany's borders and scrap fast-tracked naturalisation, among other measures.
It also announced a voluntary military service and the creation of a national security council, as well as moves to speed up defence procurement and backing Ukraine's bid to join the NATO alliance.
The 69-year-old Merz, who had previously called Trump's US an unreliable ally, has already vowed to build up defence spending as Europe faces a hostile Russia, and to support businesses struggling with high costs and weak demand.
The tougher stance on migration explicitly moves Germany away from a more liberal policy under Merz's conservative predecessor Angela Merkel during the 2015 European migrant crisis.
