He said that Sergei Ivanov will retain his duties as defense minister and added that his appointment as deputy prime minister is aimed at improving Russia's armed forces.
"During last week's Defense Ministry meeting, participants expressed anxiety about the problems the Defense Ministry has been having in realizing its plans for future development," Putin said. "These problems are connected with non-agreement of the activities of various ministries and departments."
Both Ivanov and Medvedev are trusted allies of Putin and are seen as possible successors to Putin after he steps down in 2008 at the end of his second and last term. The Russian Constitution bars presidents from seeking three consecutive terms, although there has been speculation that it could be amended to allow Putin to remain as president.
Medvedev studied with Putin at St. Petersburg's law faculty and he is also the chairman of the Russian gas giant Gazprom.
Under the reshuffle, he will be replaced by Sergei Sobyanin, governor of oil-rich Tyumen Oblast, in Siberia. Putin said Sobyanin's appointment reflected Siberia's vital role in the Russian economy.
Today's surprise cabinet shake-up has therefore fueled speculation that Putin is seeking to increase Ivanov's and Medvedev's visibility and test their performance ahead of the next presidential election.
Putin has consistently rejected allegations that he will try to seek a third term, and observers now widely predict that Putin will indeed step down in 2008 and hand-pick a candidate to succeed him.
Independent State Duma Deputy Vladimir Ryzhkov told RFE/RL's Russian Service that today's appointments clearly indicate that Putin is already preparing for the presidential election.
"What happened today signals the start of the election campaign for the 2008 presidential elections," Ryzhkov said. "There are still three years ahead, but the start was given precisely today, because both Dmitrii Medvedev and Sergei Ivanov have long been predicted as successors. For me, today's appointments indicate that Vladimir Putin does indeed not plan to run for a third term, and that he is picking a candidate whom he will recommend to Russian voters."
Putin also appointed new presidential envoys for the Volga and Far Eastern federal districts.
Some political analysts do not exclude further changes in the cabinet and there has been some speculation that Prime Minister Mikhail Fradkov, who is regarded by many as lacking charisma and political ideas, could soon be replaced.