Interest income is forbidden in a socialist society due to socialist ideology. Someone is earning income on their money, when the only legitimate from of income is from labor.
In a previous post, I described a socialist monetary policy that was based upon the issue of money to pay wages to government workers (which are all workers) and then money is absorbed as it is spent in government stores and shops (which are all of them.)
If the workers are paid by crediting deposit accounts and their accounts are debited when they purchase consumer goods and services, then the payment of interest would be technically simple. Further, it would seem that interest rates could play something like the role they do in a market economy--including one with a monetary policy using interest rate targeting. Paying higher interest would reward workers for saving. The reduction in spending on consumer goods and services would allow for a reduction in the production of consumer goods and services without creating shortages. That would free up resources to produce capital goods, which would allow for the production of additional consumer goods and services in the future. Those added consumer goods would allow workers to both spend the amount they saved as well as any accumulated interest income. Those workers who saved would be especially rewarded for allowing an expansion in total future consumption.
I was more concerned, however, with the use of interest rates as a tool of monetary policy. That is, the possibility of responding to a shortage of consumer goods and services by increasing the interest rate. As above, this should motivate additional saving and so reduced spending on consumer goods and services now. This seems to make an increase in the interest rate an alternative to increasing the prices of the consumer goods and services. Higher interest rates would reduce inflation--more or less.
Interestingly, these interest payments would seem to increase the quantity of money. In the socialist economy without interest payments, all money is created by the payment of wages to workers. Paying interest on saving would be a new source of income and a new source of money creation. An increase in interest rates would entail an increase in income and money creation. This would seem to add to the demand for consumer goods and services and so tend to create more pressure to increase their prices to avoid shortages.
Of course, this can be analyzed as an income and substitution effect. The income effect would be to increase the demand for consumer goods and services and exacerbate inflationary pressure. The substitution effect would be to reduce current consumption spending and expand future consumer spending as described above.
In a market economic system, an increase in interest rates also increase interest income but directly reduces profits (at least accounting profits.) There is no particular reason to believe that total income rises. The use of monetary policy to raise interest rates typically involves a contraction in the quantity of money rather than an expansion. Even leaving aside the impact on private sector investment (which does not exist in the socialist economy described here,) an increase in interest rates reduces expenditure. (These "decreases" frequently involve a dampening or possible reversal of increases of consumption or investment due to other causes.) The situation is much more ambiguous in the sort of socialist economy described here.
Can these considerations about the effects of interest payments on the quantity of money and income in a socialist economy be applied to a market economy? Or more especially, to a market economy in transition to socialism?