The derelict hotel in the heart of a Palestinian neighbourhood was demolished yesterday to build apartments for Jews, and the move elicited strong criticism from the United States and European Union.
Israel, however, remained unfazed and the government defended the action.
"Actions taken at the Shepherd Hotel were done by private people corresponding with Israeli law," the Prime Minister's Bureau said in a statement adding, "the Israeli government was not involved in the events".
The Shepherd Hotel controversy marked the first in a series of disputes between the Netanyahu government and the Obama administration over constructions in east Jerusalem.
The new constructions have become a symbol of Jewish settlement plans in east Jerusalem because it is located in the heart of foreign consulates and is not an extension of existing Jewish residential facility.
The Israeli statement said: "It cannot be expected from the State of Israel to forbid Jews from purchasing private property in Jerusalem".
"There is no democratic country in the world that would impose such a ban on Jews and it cannot be expected that Israel will be the one to do so," it said, justifying the government inaction to prevent the demolition yesterday.
"Just as Jerusalem's Arab citizens are allowed to buy or rent assets in Jerusalem's neighbourhoods that have a Jewish majority, Jews are allowed to rent property in a Jerusalem neighbourhood with an Arab majority," it said.
Bulldozers began razing parts of the Shepherd Hotel in east Jerusalem yesterday, a move that immediately evoked international condemnation.
The hotel, located in the Sheikh Jarrah neighbourhood of the Arab dominated part of the city, was purchased 25 years ago American Jewish businessman, Irving Moskowitz.
US Secretary of State Hillary Clinton condemned the construction work and said the move to proceed with an East Jerusalem settlement project by razing a derelict hotel "undermined the peace effort".
Egypt and Jordan, the two Arab neighbours that recognise the Jewish state, joined in condemning the move today.
