"Without stronger policy responses than have been observed to date ... there is the risk that the adverse impacts will be felt for the rest of the decade and beyond," Summers wrote in a column in the Financial Times on Monday.
Summers said the U.S. Federal Reserve should recognize that "levels of the fed funds rate that were neutral when the financial system was working normally are quite contractionary today."
The Fed has already cut the policy rate to 4.5 percent from 5.25 percent since the global crisis was triggered in August by defaults on U.S. mortgages, and financial markets expect further easing.
Summers said fiscal policy needed to be "on stand-by" to provide immediate temporary stimulus through spending or tax benefits for low and middle income families if the situation worsens.
The authorities also had to respond urgently to the contraction in credit, said Summers. "The time for worrying about imprudent lending is past. The priority has to be maintaining the flow of credit."
Summers said a "super conduit" promoted by the U.S. Treasury to take on assets of troubled structured investment vehicles (SIVs) had never been publicly explained in any detail by the Treasury. "Perhaps there is a strong case for it but that case has yet to be made," he added.
He urged the authorities "to assure that there is a continuous flow of reasonably priced loans to creditworthy home purchasers."
Summers said forward-looking indicators suggested the U.S. housing sector may be in freefall.
"It is hard to believe declines of anything like this magnitude will not lead to a dramatic slowdown in the consumer spending that has driven the economy in recent years," he said.
He also said only a small part of the financial distress that must be worked through by financial institutions had yet been faced, and warned of the potential damage to confidence from a sharply falling dollar.
"In such an environment, economic policy needs to be governed by the clear and public recognition that restoring the normal functioning of the financial system and containing any damage its breakdown may do the real economy is the central macro-economic and financial challenge facing the U.S."