An overwhelming majority of the 200 or so SPD members backed their leaders' recommendations to open formal coalition talks with Merkel following a hefty defeat for the party in September 22 elections.
"We want to start coalition negotiations and we have set ourselves the goal of carrying them out successfully," party leader Sigmar Gabriel told reporters.
"We are going to negotiate hard so that at the end of the process we have a government capable of action. For this to happen, compromises are required," added Gabriel.
The SPD will now enter into what will likely be a lengthy process of negotiating with Merkel's conservative Christian Democratic Union (CDU).
Gabriel pledged to put any agreement between the two parties to a vote of the some 470,000 rank-and-file SPD members.
Many SPD members are wary of another tie-up with Merkel, after their coalition in 2005-2009 resulted in a heavy defeat at the ballot box.
Gabriel outlined several red lines ahead of the negotiations, chief among which is the introduction of a nationwide minimum wage of 8.50 euros ($11.60).
The SPD, which campaigned on a platform of greater social justice in Germany, would also demand stepped-up measures against poverty among pensioners, improved terms for refugees and a greater assault on youth unemployment, Gabriel said.
Merkel stormed to victory in last month's elections but fell just short of being able to govern without needing a coalition partner.
She entered into exploratory talks with both the SPD and the ecologist Greens but negotiations with the latter broke down.
Long coalition negotiations are the norm in Germany's consensus-based political system and Gabriel said he hoped to "make it possible to form a government before Christmas".
"I am sure we will come to a balanced compromise," CDU secretary general Hermann Groehe told local news agency DPA.