iNTERNATIONAL NEWS - The free-market liberal FDP pulled out after four weeks of talks with Mrs Merkel's CDU/CSU bloc and the Greens.
FDP leader Christian Lindner said there was "no basis of trust" between them.
What happens next is unclear, but Mrs Merkel has met President Frank-Walter Steinmeier, who has the power to call elections.
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Mrs Merkel said she regretted the collapse, adding she would formally tell the German president that negotiations had failed.
CDU deputy chairman Armin Laschet told journalists that Mrs Merkel had held a conference call on Monday morning with the party leadership and had retained its support.
Mrs Merkel's bloc won September's poll, but many voters deserted the mainstream parties.
"As chancellor, I will do everything to ensure that this country is well managed in the difficult weeks to come," she said.
Back to the ballot box?
Analysis by the BBC's Jenny Hill in Berlin
This is - for post-war Germany - an unprecedented political crisis that could spell the end of the Merkel era.
Weakened by a poor election result in September, the proposed coalition was Mrs Merkel's only shot at forming a new government.
Germany will now - in all probability - have to go back to the ballot box. But it's not at all certain that Mrs Merkel's party will want her to lead them into a fresh election.
The ensuing uncertainty has consequences beyond Germany. Mrs Merkel - who did not attend a summit of EU leaders in Sweden last week - will remain preoccupied with domestic affairs for some time yet. This was, she said last night, a time for deep reflection.
Mrs Merkel must now fight for political survival. The leader who for so many people has represented stability now is fast becoming a symbol of crisis in the heart of Europe.
