The current debate is really about the meaning of literal interpretation. My conjecture is that covenant theology and dispensational theology believe they are each employing literal interpretation. But they cannot both be consistent in that application because of the huge chasm between them in the area of eschatology. Certainly I would not claim that reformers are not interpreting the NT literally ... but when approaching the OT the literal interpretation used in the reformed camp breaks down IMO. By projecting a NT understanding on the OT text in the interpretive process you are ignoring the OT background and removing the OT from its historical context ... which can have the effect of shifting meaning and replacement theology.
Why do dispensationalists see future promises for the nation of Israel? Because the literal interpretation of the OT text shows that the promises to the nation of Israel have yet to be fulfilled in their entirity. So, for example, the discussion on Daniel 9:24-27 (which I think started the whole discussion) the dispensationalist would come to a different understanding of this prophecy that the reformed theologian. Why? Well, as I have mentioned previously, the reformed perspective will substitute meanings for details in the text that the grammatical historical context does not support. How could you ever get that the "abomination of desolation" is the continuance of the sacrificial system between Christs death and 70 AD? You have to impose a NT theme on the OT text. At that point you have abandoned any sense of literalism.
What evidence do you have from the Bible that this use of “literal interpretation” as proposed by dispensationalists is even valid? Esp. one that ignores or minimizes the way that Jesus and the NT writers approached the subject.
You take issue with the way covenant theology reads the OT in light of the NT, but that is exactly what the apostles did. Remember, it was the apostate Jews who took a “literal interpretation” of the OT prophecies and failed to see Jesus, looking instead for a carnal political ruler who would wage a carnal political war. The same sort of person many modern dispensationalists expect to appear after the rapture and during the futurist millennium.
Dispensationalism is the odd man out since there is no justification for their definition of “literal interpretation.”