The wars and conflict driving people to Europe from troubled countries including Syria, Iraq, Eritrea and Somalia were inextricably linked to politics at home in Germany, Merkel said – adding that this was "just the start" of a new shape for politics in the 21st century.
But Germany could not just meet but overcome and profit from any challenge, however great, the Chancellor told MPs.
For example, if the country prepared itself to integrate refugees arriving in the country by teaching them German, helping them find work and get on the path to citizenship, they could "bring more benefits than risks," Merkel said.
"We should learn from the experiences of the 1960s, when we invited [Turkish] 'guest workers' here, and make integration the very highest priority from the start," she added.
She said that those committing violent acts against refugees and posting hate messages online were "repulsive and shameful" for the country, and that the government would use "the full force of the law" against them.
But the Chancellor didn't neglect to throw some bones to her conservative supporters, saying that the government would support integration but not the growth of "parallel societies".
She said that many people coming to Germany would have to be refused asylum, a comment which provoked furious applause from right-wing MPs.
And she added that "we need a binding agreement on the distribution of refugees according to fair criteria between [European Union] member states" with no hard limits on numbers.
"We can't just fix a ceiling and say I don't care about anything beyond that," Merkel said.
She went further than European Commission President Jean-Claude Juncker, who said in a simultaneous speech at the European Parliament in Brussels that 160,000 refugees should be resettled across the EU on a "compulsory basis".
The best Europeans were "the students in Munich and in Passau who bring clothes for the new arrivals at the train station," Juncker said.
"If Europe fails the refugee question, then a decisive founding impulse for a united Europe will be lost," Merkel said, "namely the close connection with universal human rights that has defined Europe from the beginning and must remain valid in the future."
Solid finances the foundation
In her speech during one of the year's biggest parliamentary debates, where MPs discuss the federal budget for 2016, Merkel said that "solid finances make it possible for us to react to new challenges that suddenly appear".
The Chancellor linked her government's sound handling of the public finances with its ability to act on multiple domestic and foreign policy fronts, ranging from improving care for the elderly and upgrading Germany's physical and digital infrastructure to arming Kurdish Peshmerga fighters in Iraq and pushing for a diplomatic solution to the Ukraine crisis.
And she said that despite the new spending on refugees her conservative-social democrat coalition would not take on any more public debt.
George Mills contributed reporting