An 18-year-old man who was being investigated over terrorism has been shot dead after stabbing two police officers in Melbourne's outer south-east.

The dead man, who recently had his passport cancelled, was considered a "person of interest" by authorities and was being investigated over terrorism.

Police said it was unclear whether earlier reports that the man made threats against the prime minister were true.

"This is early stages of an investigation. We need to understand ... if threats had been made," Acting Australian Federal Police Commissioner Andrew Colvin said.

"What I will say is and what I can be very confident on is there were no specific threats made and that's consistent with what we have said now in a range of matters in a range of forums."

The man, whose family are from Afghanistan, had been associated with the radical Islamic group called Al-Furqan.

It is understood he had recently moved away from the group.

Based in Springvale, in Melbourne's south-east, associates of Al-Furqan were the targets of terrorism raids by Victoria Police and the Australian Federal Police in 2012.

Police said an altercation between the man and the two officers took place outside the police station on Heatherton Road in Endeavour Hills about 7:40pm (AEST) on Tuesday.

He had been asked to attend an interview as part of an investigation.

Victoria Police Chief Commissioner Ken Lay said the man attacked a police officer who tried to shake his hand.

"When our police members have approached this young man, one's extended his hand to shake his hand and the response has been he's been stabbed in the arm," he said.

"The attacker's then turned on the second police member and stabbed him three or four times in the body and in the head.

"The first wounded member has then shot and killed the young man."

One of the injured officers is from the Australian Federal Police (AFP) and the other is a Victoria Police member, they were both rushed to hospital.

Chief Commissioner Lay said both police officers required surgery but were in a stable condition this morning.

AFP Commander Bruce Giles said officers were looking into unconfirmed reports the man had been seen with an Islamic State flag before he was shot.

"There is intelligence to suggest that this incident may have happened but [we're] still confirming all the details to bring the links together on that," he said.

Victoria Police Assistant Commissioner Luke Cornelius would not go into detail about why they wanted to speak to the man, but the ABC understands he had made threats against Prime Minister Tony Abbott.

Federal Justice Minister Michael Keenan confirmed this morning that the man was a known terror suspect.

"I can advise that the person in question was a known terror suspect who was a person of interest to law enforcement and intelligence agencies," Mr Keenan said.

The minister, who would not take questions as it was an ongoing investigation, urged the community to "remain calm".

"The police are our front line against people who wish to do us harm and it is exactly this type of bravery and dedication shown by these officers that will continue to keep our communities safe and secure," he said.

Stabbed officers undergo surgery

Chief Commissioner Lay said the stab wounds to the police officers were significant and required surgery.

"Our AFP colleague underwent surgery overnight for some significant injuries, he's come through that surgery it appears pretty well, he's in a serious but stable condition," Chief Commissioner Lay said.

Sorry, this video has expired Asst Comm. Luke Cornelius and AFP Commander Bruce Giles speak to the media

"Our Victorian Police member has had quite a significant stab wound to his arm, I understand he'll undergo surgery today to repair some ligament and nerve damage.

"So the physical injuries will heal quick enough and obviously we need to think about the psychological stuff and give these people as much support as we possibly can."

Mr Keenan said he was in constant contact with Prime Minister Tony Abbott, who is overseas, as well as the Acting Prime Minister, the Attorney-General and the Leader of the Opposition.

"I want to make it clear that the public should feel confident that the police, the security services and the Government are taking every possible step to ensure their safety and the security of all our communities," he said.

"We are protected by the best law enforcement and security agencies in the world and we need to let them deal with the task at hand."

'This individual was acting on his own'

Mr Cornelius stressed the man came to the station of his own freewill.

"It's absolutely clear to us that our members had no choice other than to act in the way in which they did," he said.

"This is not an exercise in police seeking to single out particular individuals in the community."

The shooting and stabbing took place near the Endeavour Hills police station. ( ABC News )

Mr Cornelius added police believed this was an isolated incident.

"It appears this individual was acting on his own and was not acting in concert with other individuals," he said.

A large number of uniformed and plain clothes officers attended the scene late on Tuesday night, with officers interviewing witnesses from a nearby shopping centre.

Space to play or pause, M to mute, left and right arrows to seek, up and down arrows for volume. Listen Duration: 3 minutes 9 seconds 3 m 9 s Police shoot knife-wielding 18-year-old dead in terrorism investigation Download 5.8 MB

The incident has occurred amid heightened tensions following last week's counter-terrorism raids in Sydney and Brisbane.

On Monday, Mr Abbott warned Australians the balance between freedom and security "may have to shift", given the current "troubling" and "darkening" security situation.

In Canberra on Tuesday AFP officers armed with assault rifles could be seen outside Parliament House.

The decision to post the heavily armed police officers outside Parliament House was taken by Speaker Bronwyn Bishop and President of the Senate Stephen Parry based on advice from security agencies.

It also comes after the Federal Government released its second round of new counter-terrorism laws targeting so-called foreign fighters.

The bill would make it an offence to travel to or remain in an area declared to be of terrorist activity, advocate terrorism, and lower the threshold for authorities to be granted control orders and preventative detention orders.

The Government said the legislation would give security agencies extra "tools" to investigate, arrest and prosecute people supporting foreign conflicts.

Islamic council calls for investigation

The Islamic Council of Victoria has called for an investigation into the incident which they said "on face value, should not have cost a young man his life and put two police officers in hospital".

"There needs to be a full and objective investigation into this incident to ensure that such a tragedy is never repeated," the council said in a statement.

The council said the incident highlighted the consequences of the Government's failure to address the root causes of disaffection.

"The tragedy highlights the real cost of a failure to deal with these serious issues and why we have made numerous calls on the Australian Government to deal with the root causes of alienation and disaffection of people such as this," the statement said.

"This is not about laying blame but about a genuine need to identify the root causes and deal with them so that no further tragedies such as this occur again."

The council said for now they were concentrating on supporting the family of the 18-year-old.

"There will be many questions that they will want answers to and in the fullness of time we expect the the events of last night will become clearer."