A Palestinian in a mechanical digger has rammed traffic in west Jerusalem, injuring at least 10 people before being shot dead.
A bus and a number of cars were hit during the incident. Some cars were crushed and one was turned on its roof.
Witnesses say an armed civilian first shot at the driver, before he was killed by border police.
Three weeks ago a Palestinian man went on a deadly rampage in a heavy vehicle in Jerusalem, killing three Israelis.
The BBC's Paul Wood in Jerusalem says it is thought the 2 July attacker was simply a disturbed man without political motivation - but Israelis will worry Tuesday's incident was a copycat attack and that this could now be a new tactic.
Police identified the perpetrator as 22-year-old East Jerusalem resident Ghassan Abu Tir. It is not known if he was connected to any militant group.
The latest attack took place in a busy part of central West Jerusalem, close to the King David Hotel - just hours before US Democratic presidential hopeful Barack Obama visited the city.
As the incident was unfolding, Israeli President Shimon Peres was for the first time receiving Palestinian leader Mahmoud Abbas at his official residence in Jerusalem, which is also nearby.
"I was going home when I saw the tractor going into a bus four or five times. All the windows of the bus exploded," said a 16-year-old Israeli at the scene.
"Then I saw the tractor going down the street pushing cars. I saw more people running and after two minutes I heard two or three gunshots," Yohanan Levine added.
A driver interviewed by Israeli TV said his car was rammed twice by the front shovel of the digger and he only just managed to swerve to avoid a third charge aimed at his head.
Photographs of the immediate aftermath show the driver's body slumped in the cab and at least eight bullet holes in the glass next to him.
Ten people, including a baby, were injured in the incident. A number of people were treated for shock.
Israeli police called it a "terror attack", although there was no immediate claim of responsibility by any Palestinian militant organisation.
Police said the driver was from a Palestinian village in the occupied West Bank, which Israel has designated part of the enlarged Jerusalem municipality.
Mr Abbas told reporters he "condemned and rejected" the attack and said such incidents "hurt our reputation and peace in general".
It was the first time a Palestinian Authority president had visited the Israeli presidential residence, known as Beit Hanasi.
Mr Abbas was welcomed in a formal ceremony with Palestinian flags flying at the reception point. Such trappings are normally absent when Mr Abbas meets Israeli Prime Minister Ehud Olmert at his official residence.
In his remarks, Mr Peres said: "Israelis have a burning desire to reach peace with the Palestinians."
Mr Abbas has been meeting Israeli leaders regularly since attempts were made to give the peace process fresh impetus at an international conference in the United States last November.