Balotelli's goalscoring woes continued on Sunday as the £16m summer signing missed a series of chances - including an open goal - in the Reds' 3-2 win away to Queens Park Rangers.
With their Champions League encounter with the title holders on the horizon, Carragher champions the idea of benching the misfiring striker to facilitate the pacey Sterling in a central role.
"He doesn't run around enough," he told Sky Sports News. "Against Real Madrid you've got to get that crowd going. You need to get back to Liverpool of last year and that pressing.
"It's going on too long now and we can't keep waiting. It's a huge game and Liverpool have to get something from it. I would put Raheem Sterling in there because he can run in behind and Liverpool may have to counter-attack a lot of the game.
"Sterling can also press from the front. He doesn't have to play right up front and he can come back and help the midfield. They can't have any passengers against Real Madrid."
Twenty-four-year-old Balotelli is without a goal in six games for the Merseysiders, with his only strike coming in last month's win at home to Ludogorets Razgrad.
Wednesday's clash at Anfield kicks off at 7.45pm.