Steinmeier, whose SPD trails Merkel's conservatives by double digits in the polls two weeks before an election, went on the offensive at the outset, criticising his rival for resisting a minimum wage and limits on manager salaries.
"The question is which path we choose to get out of this crisis," said Steinmeier, 53, looking relaxed in a black suit and red tie. "A centre-right government would mean that the divide between rich and poor widens and that nuclear energy makes a return."
Merkel appeared on edge at the start but grew more comfortable as the debate went on. She said the SPD could link up with a far-left party that includes former communists after the 27 September vote - a step Steinmeier has ruled out for Berlin, though the alliance has emerged in some regions.
"We do not have a guarantee that this would not happen," said Merkel, 55, who is Germany's first woman chancellor and the first to have grown up in the former communist east.
Snap polls released after the debate showed viewers were divided on who had won the US-style TV clash, which was expected to be watched by up to 20 million viewers.
But most analysts gave the edge to Steinmeier, who appeared the more dynamic and confrontational of the candidates. Steinmeier has served as foreign minister in Merkel's "grand coalition" for the past four years, and the rivals have mostly shied away from aggressive attacks during the campaign.
"Steinmeier did better than Merkel, considering what one expected from him," said Hans Vorlaender, a political scientist at the University of Dresden. "He was a better debater and more focused, but whether that actually mobilises voters is not certain."
Centre-right in question
Although the SPD trails Merkel's conservatives by 11-14 points in the polls, pollsters estimate that up to 40% of voters are still undecided, giving the US-style TV clash added importance.
Despite the substantial conservative lead, it is also far from certain that Merkel will get enough votes to form her centre-right coalition of choice with the Free Democrats (FDP).
She had a similar lead in the polls in 2005 but lost a TV debate to then-Chancellor Gerhard Schroeder weeks before the vote and ended up beating the SPD by one percentage point — a result which forced the rival parties into government together.
The 90-minute debate touched on Afghanistan policy and the rescue of carmaker Opel, but focussed mostly on the economy.
Germany recently emerged from its deepest recession since World War Two and both parties want to convince voters they are best placed to protect jobs and get the economy going again.
Merkel said she would stimulate growth by "lowering certain taxes to motivate workers" and warned that with the SPD's solutions, Germany would "stay at economic rock bottom" for years.
Steinmeier said Merkel's pledge of tax cuts at a time of surging deficits lacked credibility and attacked her vow to extend the life of some nuclear energy plants - a politically divisive issue in Germany.
"It is not responsible, and it is politically wrong to go back down the road of nuclear energy," Steinmeier said.
If Merkel is unable to seal her preferred coalition with the FDP, Germany could have another "grand coalition", an uneasy partnership which worked well during the financial crisis, but which analysts fear would be less stable and more beset by in-fighting in the future.
Afghanistan plan to win votes for Steinmeier
Steinmeier has drawn up a plan to withdraw German troops from Afghanistan by 2013, a move that could win votes two weeks before the election, the magazine Der Spiegel reported on Sunday.
"In the next legislative period, it is valid to create the basis for a withdrawal from Afghanistan," Der Spiegel quoted the Steinmeier's paper as saying. "We must set the right course now."
A spokeswoman for the foreign ministry confirmed Steinmeier had approved a paper entitled 'Ten Steps For Afghanistan', but declined to comment on its content.
(EurActiv with Reuters.)
