It is made clear in every epistle that God’s Spirit works real transformation within a believer. The Apostle Paul generally ties that process directly to the sacraments. I don’t know of a protestant that disputes the point. Since, however, protestant theology is continually expressed through its historical conflicts, it often seeks to emphasize that the transformation is to be understood entirely in the optic of gift–Mary is the perfect example–and not human effort.
On the other hand, the epistles are also full of exhortation to live out the transformation that is effected upon us. This indeed does take human effort, and lots of it, like beating one’s body to make it one’s slave. Lutheranism as I have been taught it would explain these exhortations within the rubric of “two kinds of righteousness”. Its tagline goes “God doesn’t need my good works but my neighbor does.” The effort one puts into the Christian life contributes to one’s horizontal righteousness. This action flows from the vertical righteousness that is pure gift apart from any effort of my own. The horizontal needs to reflect the vertical but the two must not be confused.
The bone that could be picked with pietists (that is, much of popular evangelicalism) is that that latter encourages an examination of horizontal righteousness as proof and validation of the vertical. This is a confusion, indeed, the very definition of legalism, since horizontal righteousness is a always a one-way street, pure gift, Christ’s merit alone, etc.
It is true that grace changes our very being, filling us in Christ. Nowhere is this expressed more clearly than Colossians. But even in Colossians there is that phrase “you have died and your life is now hidden with Christ in God”. It is this hiddeness that I think needs to be understood. The ontological transformation that is the work of grace is a hidden one. It is not relegated to the eschaton, but perhaps its revelation is. Not that its revelation is entirely delayed until the echaton, but that we certainly will not reveal it by our efforts. We can only seek to live (and indeed are called to live) ever more in accordance to it as the Spirit reveals its truth when, where and how he sees fit in his inscrutable plan.
I think this view is very consistent with Paul’s presentation in the epistles. He sets up the spiritual reality of our transformation in Christ by grace in stark contrast to our current sinful behavior so as to motivate us to live more consistently with the hidden reality. The horizontal righteousness is motivated by the vertical. The transformation of our being happens in the former and flows out to effect the latter. We have faith that the Spirit works through all things, including and especially the efforts of God’s people to live out their salvation. But he does so in his inscrutable timing and way. What we really want to avoid is the navel-gazing, that interminable search for evidence, proof, validation of vertical righteousness in any place other than the sacraments. Because any such search will lead, and historically always has led, to legalism and guilt. And I think that is the answer to why so much of pietism eventually became liberalism. The grandchildren of legalist are anything but.