Real were beaten home and away by the Gunners and eliminated from the competition 5-1 on aggregate.
Balague told BBC Sport: "Real Madrid stand at the crossroads. They have a squad in need of refreshing. The defeat to Arsenal hasn't caused a reset, it has simply confirmed the need for it.
"For Ancelotti the message will be clear - it's time to move on."
He added, "This is a squad that needs new energy. Toni Kroos has never truly been replaced, the midfield lacks control. While Luka Modric remains a legend, the need for someone who can control the tempo without being 39 years old is obvious.
"The club has to face hard decisions this summer."
