I think for such a good morality system, the responses would need to be altered by more than colors, and altered from more than those four possibilities. I can't think of something that doesn't lead to a procedural conversation generator though.
Well, you have to start somewhere and, from a game play perspective, thinking about your average schmoe NPC you deal with, you don't need more than that, at least for non-major characters. If you want something from any NPC you deal with (even if it's just a reaction), all you really need to know is how that NPC is going to react to you. You COULD decide that accepting but disdainful, snide but accepting, and all those variants are important, but at the end of the day, they're really not for game play. That's all flavor, and could be expressed through a few different tone variants and facial expressions. In a game sense, they still either have to approve of you, disapprove of you, don't care, or want to kill you. A real person is usually limited to those choices when dealing with others. Sort of like if you asked someone to state their simplified, ultimate opinion of another person.
You also don't need a procedural conversation generator for this, because that's still way too complex and micro I think for what most people expect out of an RPG. You just need to know that your choices are having an impact in the way people react to you, and that it can be subtle as well as overt. Right now, we basically have "like, don't care, and kill on sight" and all game play is driven by those three beliefs. So there's really no middle ground. Adding two more states, that THEN play off a lot of individual actions by the player, would add a lot of depth and increase the range of responses, reward or punishments that can be dealt out.
It would be much harder to figure out just what attributes (virtues and vices) are modified based on choices in DF, since there are just so many choices. I guess charity and greed wouldn't be that hard, but it would be dependent on just how much the NPC cared about whatever it is. Giving all your gold away to desert tribes who want your water, probably wouldn't be very charitable, even though a foolish character might think it so.
Again, think macro vs. micro. Important people, yeah, you'd want their perception to matter a lot. But all the people that fill out the world? Not so much. You can abstract their opinions away into much smaller and more manageable chunks. You mix and match changes in morality as well, so you're not just throwing money at poor people to get your "charity" score up.
So something like, there's a criminal in town who stole to feed his kids. You track him down and he says you'll have to kill him to stop him. So you do.
Peace value goes down, violence value goes up.
Compassion value goes down, stern value goes up. (Can't think of a good word that is the opposite of compassion atm.)
Law abiding goes up, and criminal goes down.
So your actions have a large impact on your own morality, and by extension, to the rest of the game world and not in a simplistic one or two combination way. And some morality would be weighed more heavily than others, or the relative difference between them needs to be higher for one to cancel out the other. So you could get to something like Robin Hood for example, where you can be a likable celebrated criminal, even though you're still a criminal.
I'm not sure if dynamic change would work very well for the NPCs, since their choices are based on the morality, but the choices are meant to change the morality. So it would either mean things would stay just the same or would create loops. There's change by experience, but that isn't dynamic the same way as the player's would be.
Again I think this would be a macro vs. micro kind of thing. I'd want major, important character's morality to be able to shift based on what they do or you cause them to do. The filler? Maybe not, although it would allow for things like a nice peaceful town turning violent because, say, an NPC group of bandits moves in and forces them to start fighting to defend themselves. And this in turn makes a violent player character more acceptable to them. Maybe the player has started killing townsfolk, and that has the natural result of making everyone more violent (not necessarily accepting of murder, or lawlessness.)
That it could create cyclical feedback loops is actually realistic. Assuming the change took long enough to be noticeable and feel meaningful, I don't know if the loop is really a problem. It'd be worse to have moralities that would change with NO hope of changing them back.