She said she was "angered" by German auto giants who in the "dieselgate" scandal either broke the law or used legal loopholes, but also pointed to the at least 800,000 jobs in the crucial industrial sector.
Speaking just over a month before September 24th elections, Merkel was asked in an online video interview with top-selling Bild newspaper about motorists' fears about the falling resale value of their diesel cars.
She pointed to new software updates designed to fix the emissions problem and said that "in order to prevent or reverse the drop in value of diesel cars, we need to restore trust in diesel".
To this end, she stressed that she opposed plans by some German cities to fully or partially ban diesel cars from urban areas which have recorded high air pollution levels.
Merkel said "that will be hard work" and the subject of a "summit" with the municipalities involved which she plans to hold on September 4th.
The industry's fall from grace began in 2015 when Volkswagen admitted to installing software in 11 million diesel engines to cheat emissions tests, and suspicions later spread to other manufacturers.
The scandal sparked by a US investigation deepened on reports last month that Daimler, BMW, VW and its Audi and Porsche subsidiaries had long colluded on technical specifications including emissions technology.
The damage done to the 'made in Germany' brand, along with concerns over pollution and plans by some cities to ban dirty diesels, have fuelled public anger.
Merkel said in the Bild interview that her government must balance the concerns of car owners, auto workers and the industrial sector, without explicitly mentioning public health concerns.
Merkel was dubbed the "car chancellor" in 2013 after she went to bat for the sector and argued against an EU cap on emissions.
But her election opponents, the centre-left Social Democratic Party (SPD), also have cosy links to the sector.
In the state of Lower Saxony, which holds a 20-percent stake in Volkswagen and two seats on its board, recent revelations that SPD premier Stephan Weil allowed VW to vet his comments on dieselgate sparked outrage.