It was the second construction vehicle attack in Jerusalem this month. Three people were killed and dozens injured in a similar attack on July 2 about three miles away.
Tuesday's attack took place less than 200 yards from the King David Hotel, where Democratic presidential candidate Barack Obama was due to arrive hours later.
Police said that a civilian driving near the scene jumped out of his car and shot the attacker, according to the Associated Press. The backhoe continued moving, and the attacker was shot again by a border policeman who ran to the scene.
Palestinian sources identified the driver as Ghassan Abu Tir, according to the New York Times.
"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 witness Yohanon Levine, a 16-year-old Israeli, according to BBC News. "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 quickly."
Another eyewitness, Moshe Feiglin, told Reuters "The first thing I saw is that he tried to smash the head of a passerby with the [backhoe's] shovel. Then he zigzagged down the street, smashing into cars."
Israeli officials called the attack an act of terrorism.
"This was another attempt to murder innocent people in a senseless act of terrorism," said government spokesman Mark Regev, according to the AP. "All people who believe in peace and reconciliation must unequivocally condemn this attack."
No group claimed responsibility for the act, but Hamas officials in the Gaza strip praised it as "a natural reaction to the crimes of the [Israeli] occupation," according to the AP.
The three most recent attacks in Jerusalem have been carried out by Palestinians from the city's eastern sector, which Israel captured along with the West Bank in 1967. Palestinians who live there make up a third of Jerusalem's population, and although they are not Israeli citizens, they carry ID cards that allow them to move and work throughout Israel. Many work in construction in Jerusalem's Jewish neighborhoods, according to the AP.
"They keep on inventing ways to attack us," Jerusalem Mayor Uri Lupolianski said, according to the AP. "Every work tool has become a weapon."