In his book, According to Plan, Graeme Goldsworthy differentiates among literalism, allegory, and typology. He distinguishes the church's historical method of interpretation from the literalism that has come to dominate in many corners of evangelicalism. He then distinguishes typlogy from allegory since literalists tend wrongly to call typologists allegorists.
Literalism is the error of "not listening to what the New Testament says about fulfillment." A literalistic approach to interpreting the Old Testament assumes that the fulfillment of a promise can only take place in terms of its exact historical form. It fails to recognize New Testament priority in interpreting the Old Testament and so assumes that "the meaning of history is self-evident." For example, when Hosea 11:1 says, "Out of Egypt I have called my son," literalistic interpreters insist that the promise as it was given in the Old Testament refers only to God's delieverance of Israel from Egypt. They deny that that the Old Testament promise itself has any reference to Christ in spite of Matthew 2:15.
Allegory is reading a hidden meaning into a text without any reference to its historical context. For example, on an allegorical reading of the flood narrative, the boat is Christ, the water is God's wrath, Noah and his family are believers, the dove is the Holy Spirit, the sealed door is the perseverance of the saints, etc. Goldsworthy writes, "If literalism assumes that history is self-evident, then allegory assumes that history is worthless as history." So, the allegorist disregards the story line of the Old Testament and reads systematic New Testament theology into the Old Testament without any regard for Old Testament history. This form of interpretation is entirely subjective.
Typology grows out of the principle of progressive revelation, which recognizes that truth is clarified throughout redemptive history and that prior revelation can and should be colored and interpreted by and in light of subsequent revelation. For example, Abraham was the father of a nation of God's people and he was a blessing to many nations, both in his own time and in subsequent generations of Old Testament history. But the story of Abraham pictured something larger. The New Testament explicitly "tells us that the descendent of Abraham to which all this points is Jesus Christ." Jesus Christ is the head of a company of redeemed human beings and all the nations are blessed through and in him. Abraham was the type and Christ is the antitype. Thus, typology takes into account both the literal history of the Old Testament but at the same time recognizes that that history points to something beyond it. Goldsworthy writes:
"Typology rejects the principle of literalism. The meaning of history, so far from being self-evident, depends on revelation for its meaning. It also rejects the principle of allegorism. History, far from being meaningless, is controlled and interpreted by God in revelation. Typology assumes that all history is God's history, and that God has used a particular part of history along with his word to reveal himself to mankind."
The Protestant Reformers moved away from the allegorizing tendencies of the Middle Ages and sought to employ a literal hermeneutic. A "literal hermeneutic" is different from "literalism." During the Protestant Reformation the words "literal" or "natural" simply meant that the text should be interpreted according to its meaning. But, the Reformers believed that the literal meaning of an Old Testament text is only exhausted after it finds its fulfillment in the New Testament revelation of Jesus Christ.