Timing matters. Current price dynamics point to subdued inflationary pressures. Both consumer and producer prices remain low, and in recent years, nominal GDP growth has at times trailed real GDP growth, underscoring the depth of demand weakness. In such an environment, a moderate rise in inflation would not be a policy failure, but a welcome normalization. It could help stabilize nominal asset prices — including in the property sector — and improve expectations. More importantly, it creates space for policy expansion without the usual risk of overheating.

This context reshapes how one should think about fiscal stimulus measures. Traditionally, public spending in China has leaned heavily toward physical investment, particularly infrastructure and public works. While that model has delivered results in the past, its marginal effectiveness has been somewhat diminished. More recently, there has been a shift toward investing in people, such as through social security and public services. This represents a meaningful evolution, but it also introduces new constraints. Social spending tends to be rigid: once benefits are raised, they are difficult to reverse, even if fiscal conditions tighten. Other short-term measures — such as direct transfers or consumption subsidies — may offer only temporary boosts, sometimes at the cost of future demand.

Addressing local government debt presents another possible avenue for policy intervention, yet it is fraught with complications, too. Without deeper institutional reform, debt relief risks encouraging renewed borrowing, while large-scale central government intervention raises legitimate concerns about long-term fiscal capacity.

It is against this backdrop that investing in reform emerges not as an abstract slogan, but as a practical policy framework. The logic is straightforward. Many of the reforms China now needs — whether in local public finance or in social security — are widely recognized, but costly to implement. The transition from the current system to a more efficient and equitable steady state often involves significant one-off expenditures, compensation mechanisms and institutional adjustment costs. These transitional burdens can delay or dilute reform.

Yet in a macroeconomic environment defined by insufficient demand and low inflation, these very costs can be reframed. Rather than viewing them as obstacles, policymakers can treat them as stimulus vehicles. By deploying fiscal expansion, supported by accommodative monetary policy to finance these transition costs, it becomes possible to support short-term growth while clearing the path for long-term reform. In so doing, the policy not only avoids adding to future fiscal burdens, but may ultimately reduce them by improving the efficiency and sustainability of the system.

This approach has its precedents. In the late 1990s and early 2000s, China undertook a far-reaching restructuring of its banking sector, including the large-scale disposal of nonperforming loans. At the time, the scale of intervention was striking relative to the size of the economy. Yet it did not lead to runaway inflation. More importantly, it enabled deeper reforms — strengthening corporate governance, introducing market discipline and preparing banks for commercialization and public listings. In retrospect, this period can be understood as a form of "investing in reform" — using substantial fiscal and financial resources to remove structural impediments and lay the groundwork for a more resilient system.

Today, two areas stand out where a similar logic could apply.

The first is local government debt. The burden of debt has become a constraint on local fiscal capacity and a source of broader economic uncertainty. A short-term solution might involve the central government issuing bonds to replace higher-cost local debt, with monetary policy playing a supportive role in stabilizing financial conditions. But such measures cannot stand alone. Without reforms to the fiscal system and local financing mechanisms, including reducing reliance on land-based revenues and clarifying expenditure responsibilities, the underlying problem would persist. The key is to combine debt resolution with institutional change, ensuring that today's relief does not become tomorrow's new risk.

The second area is social security reform, particularly in healthcare. China's dual-track system — separating urban worker insurance from household schemes — has long produced disparities in coverage and benefits. This fragmentation not only raises equity concerns, but also suppresses healthcare demand and constrains the development of the broader health sector. There is significant room for expansion in healthcare services, and demand for better provisions is strong. At the same time, excessive cost controls can, in some cases, undermine incentives for innovation in pharmaceuticals and medical devices.

Reform could proceed in stages. In the short term, narrowing benefit gaps — especially for inpatient care — could address the most pressing inequities without triggering excessive demand. Over the longer term, a more integrated system could emerge, potentially extending employee-based coverage to family members and gradually reducing disparities. Such changes would entail substantial fiscal costs, particularly during transitional periods. But in the current macroeconomic environment, these costs are more manageable, and the long-term gains — in terms of both efficiency and fairness — could be considerable.

None of this, however, can succeed without clear policy discipline. The coordination between fiscal and monetary policy must operate within well-defined boundaries. Monetary support for fiscal expansion should be explicitly tied to conditions of deflationary pressure and should be withdrawn once the economy returns to a path of moderate inflation. This is essential to prevent policy overreach and to anchor expectations.

Equally important is the strict use of funds. The additional resources generated through policy coordination must be directed toward the transitional costs of reform, not toward sustaining structurally unsustainable spending. In this sense, this approach differs fundamentally from Modern Monetary Theory or the shortcomings of Japan's "Abenomics". While MMT often downplays fiscal constraints, reform is the precondition, and policy support is a targeted instrument to facilitate it.

Questions about distribution inevitably arise. A moderate rise in inflation — say, around 2 percent — can be seen as imposing a form of "inflation tax", reducing real purchasing power. But this effect cannot be evaluated in isolation. Its impact depends on how the associated fiscal resources are used. If they are directed toward areas such as healthcare reform, the benefits are likely to accrue disproportionately to lower and middle-income groups. Combined with improvements in employment, public services and asset price stability, the overall effect could be to enhance, rather than weaken, income distribution.

Ultimately, the idea of investing in reform points to a more integrated policy paradigm, one in which short-term macroeconomic management and long-term structural change are not treated as separate tasks, but as mutually reinforcing objectives. It recognizes that the costs of reform are real, but also that under right conditions, they can be productively financed.

In a period marked by both cyclical weakness and structural transition, the question is not whether to act, but how. Aligning fiscal and monetary policy around the goal of reform offers a path that addresses both the immediate need for consumption support, and the longer-term imperative of building a more efficient, equitable and sustainable economy.

The writer is dean of the School of Economics and Management at Tsinghua University. The article is translated from a recent speech by Bai at CF40 Quarterly Macroeconomic Policy Forum.

The views do not necessarily reflect those of China Daily.