The 40-year-old has taken over from Gerardo Martino, who left the position of Friday morning.
Arce took charge of Paraguayan First Division club Rubio Nu after retiring from football in 2006.
"From this date forward, Francisco Arce is no longer the coach of Rubio Nu and he assumes the position of coach of the Paraguay national football team," Alejandro Dominguez, vice-president of the Paraguayan Football Association, told a press conference.
"He will have all the freedom to work, just like all his predecessors did. We will support him at all times."
Arce made 61 appearances for the Paraguay national side, scoring five goals.