O'Neill revealed he first thought of moving Milner inside from the flanks following a conversation with England boss Fabio Capello - who asked about deploying him at right-back.
Since then he has "exceeded everybody's expectations".
"I talked to him at the start of the season because I had played him right back in one or two games," said O'Neill to Villa's website.
"I met Fabio Capello out in Spain and Fabio was asking about James and I said he's a wonderful fellow.
"He said 'do you think he could play right-back?' I said he could play right-back but that is not his position.
"So I relayed this conversation to James who was delighted to hear that Capello was even speaking about him and we were then talking about where I could see him playing.
"In fact, I actually saw him being able to play centre midfield and I think he'll admit that.
"So we waited until Downing became fit to put him in there and while he has probably exceeded everybody's expectations, I still expected him to make a fairly decent impact in there."