The question at hand is "How does the pursuit of personal holiness and God's grace relate?" How do we know that we aren't being legalistic? How do we know that we aren't being licentious? How do we know that we are pursuing holiness in a way that honors God and is motivated by the gospel?
Dane Ortlund, over at the Gospel Coalition blog, responds to a recent article in Christianity Today. For context, I encourage you to read the whole post, even if it's just to get an wonderful example of how to lovingly disagree with someone through the internet. But, for the sake of brevity, I just wanted to include a few paragraphs where I believe Dane provides excellent insight into the subject of gospel-centered obedience.
He is basically responding to the question, "How are radical obedience and personal holiness to be encouraged?" Here is his answer:
One way is to balance gospel grace with exhortations to holiness, as if both need equal air time lest we fall into legalism on one side (neglecting grace) or antinomianism on the other (neglecting holiness).
The other way, which I believe is the right and biblical way, is so to startle this restraint-free culture with the gospel of free justification that the functional justifications of human approval, moral performance, sexual indulgence, or big bank accounts begin to lose their vice-like grip on human hearts and their emptiness is exposed in all its fraudulence. It sounds backward, but the path to holiness is through (not beyond) the grace of the gospel, because only undeserved grace can truly melt and transform the heart. The solution to restraint-free immorality is not morality. The solution to immorality is the free grace of God—grace so free that it will be (mis)heard by some as a license to sin with impunity. The route by which the New Testament exhorts radical obedience is not by tempering grace but by driving it home all the more deeply.
Let’s pursue holiness. (Without it we won’t see God: Matt 5:8; Heb 12:14.) And let’s pursue it centrally through enjoying the gospel, the same gospel that got us in and the same gospel that liberates us afresh each day (1 Cor 15:1–2; Gal 2:14; Col 1:23; 2:6). As G. C. Berkouwer wisely remarked, “The heart of sanctification is the life which feeds on justification.”