While Mrs Merkel’s opposition Christian Democrats made a narrow gain against Mr Schroeder’s Social Democrats, winning 225 seats to 222, neither side secured a ruling majority.
However both candidates insist they have won a mandate to form the next government, sparking intense negotiations with minor parties.
Provisional results have given the Christian Democrats 35.2 percent of the vote against 34.3 percent for the Social Democrats, the party’s worst result since World War II.
Germany now faces days of political uncertainty, which could result in the two parties forming a coalition.
The pro-business Free Democrats won 61 seats, a new alliance called the Left Party had 54 and the Greens, junior partner in the current government, won 51.
Support from Mrs Merkel’s preferred coalition partners, the Free Democrats, would still not give her enough to form a centre-right majority.
Germany’s complex voting system means there could be further shifts in the balance of seats as final ballots are counted.
Nevertheless, Mrs Merkel said she has the upper hand and she will negotiate with all the major parties on creating a coalition.
“We are the strongest party and want to form the government,” she said.
But the charismatic Mr Schroeder, 61, also insisted he has been confirmed in power after seven years in office.
“I feel I have won approval to provide a stable government for the next four years under my leadership,” he told a euphoric crowd at SPD headquarters, his hands clasped above his head.
The results mean the parties led by Mrs Merkel and Mr Schroeder may be forced into an unwieldy grand left-right coalition, a prospect she has labelled a recipe for gridlock.
Mr Schroeder said his party would never enter into a coalition under Mrs Merkel, who had been tipped to win the election and become Germany’s first woman chancellor.
He is counting on winning over the Free Democrats to join his Social Democrats and the Greens, his current junior government partners, forming a so-called traffic light coalition for the party colours red, yellow and green.
But FDP leader Guido Westerwelle, recognising his role as possible kingmaker, vowed not to abandon Mrs Merkel in favour of Mr Schroeder and said he is counting on a shift in the results as the last ballots are counted.
“We hope that as the evening wears on, we will have enough to govern with the Christian Democratic Union … if not we will remain in the opposition,” Mr Westerwelle told supporters shortly after voting ended.
The FDP’s result means it is now the country’s third strongest party.
The Greens reached about 8.1 percent, better than forecast but not enough to save the government in its current form.
A three-way left-wing coalition featuring the Social Democrats, the Greens and the Left was ruled out by each of the parties, mainly due to the bad blood with the Left Party’s chief candidate Oskar Lafontaine, a former SPD leader and finance minister who resigned early on in Mr Schroeder’s reign.
Mrs Merkel, too, refused to negotiate with the far left, saying she planned to “talk to all political parties, except the Left Party” in her attempts to form a governing coalition.
Nearly 62 million Germans were called to the polls after Mr Schroeder forced through the election a year ahead of schedule, in an attempt to obtain a fresh mandate for his disputed economic reform drive.