In MED you can create interpolated frames, but only one by one.
You have to copy the first frame to the end of the animation, because it doesn't interpolate between the first and the last, but only between one frame and its follower.

This is the result of my tests, nothing exciting, just a slightly moving 'carpet' or 'curtain'.
cloth.mdl
cloth_physics.blend

http://www.puppenheim.org/
http://www.wuerfels-welt.de
Old Game Tutorial: http://www.puppenheim.org/MITutorial.zip
Free Game Editor: http://puppenheim.org/AlienalsWeihnachtsmann.zip
http://www.puppenheim.org/blender_starting_main_settings.txt