Infrastructure Minister Åsa Torstensson announced the decision to approve the Citybanan project in a statement on Thursday afternoon.
"The Citybanan will substantially increase railway capacity through Stockholm, which will make it possible to provide increased and more punctual traffic to and from Stockholm," Torstensson said.
Former Stockholm mayor Carl Cederschiöld has been given a renewed mandate to negotiate co-financing deals for the tunnel and associated rail links.
The government said it was also pleased with progress being made on planning for a road bypass of Stockholm, adding that the decision on Citybanan did not change its view on the need for quick work on the road project.
Current Stockholm mayor Kristina Axén Olin, said she was delighted by the news.
"It is a day of joy, not only for Stockholmers but for the whole of Sweden, as we will now get a properly-functioning railway system," she said in a press release.