Germany's conservative Christian Democrats (CDU) and centre-left Social Democrats (SPD) have reached a deal to form a coalition government.
Angela Merkel has a tough reform agenda for Germany
The deal followed four weeks of painstaking negotiations after inconclusive elections.
Party members said they had agreed to tackle Germany's budget deficit by raising some tax rates and cutting public spending.
CDU leader Angela Merkel is to become Germany's first woman chancellor.
1. Christian Democrats/Christian Social Union (CDU/CSU): 226
2. Social Democrats (SPD): 222
3. Free Democrats (FDP): 61
4. Left Party: 54
5. Greens: 51
Reports say top wage earners will have to pay an extra 3% in income tax, VAT will rise by 3% and social insurance contributions will also go up.
Both parties will hold conferences next week to ratify the accord before the coalition submits to a vote in the German parliament on 22 November.
The elections on 18 September left neither the SPD nor the CDU and its Bavarian sister party, the CSU, with a majority in the Bundestag, the lower house of Germany's parliament.
"I am pleased to tell you that the pact for the second grand coalition on the federal level in the history of the federal republic of Germany is finished," a smiling Mrs Merkel said on Friday.
The deal covers 130 pages of policy detail.
But the BBC's Ray Furlong in Berlin says there is not much optimism in Germany that this government will be able to address the country's key problem of mass unemployment.
Details of the coalition agreement have drawn withering criticism from industry leaders, opposition politicians and trade unions, he reports.