Jerusalem city council said in a statement it planned to use 50 million shekels ($12.5 million, 10.2 million euros) to fund construction of a park, children's playgrounds, green spaces and new street lighting in Har Homa, as well as football and basketball grounds.
It did not give a precise timeframe for the spending plan, only saying work would begin "in the near future".
Construction first began on Har Homa -- or Jabal Abu Ghneim as the site is known to Palestinians -- in 1997, well after the Israeli-Palestinian peace agreement.
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It sparked violent Palestinian protests and a freeze by the Palestinian Authority of high-level contacts with Israel.
The settlement construction is considered a breach of the Oslo accords by the Palestinians but not by Israel, which does not see east Jerusalem as occupied territory.
A string of deadly attacks and clashes between Palestinian demonstrators and Israeli police have sent tensions soaring in recent months.
Israel captured and annexed east Jerusalem in 1967 and views the whole city as its capital but the Palestinians want the eastern sector as the capital of a future state of their own.