Jacob the Liar tells the story of Jacob Heym, a Jewish shop owner who was forced into a Jewish ghetto in Poland during World War II. One night, Jacob is accused of being out after curfew and is sent to the military office for his punishment. There, he hears a radio bulletin reporting on a battle between German and Russian forces twelve miles from the town of Bezanika, which is a relatively nearby town. The next day, Jacob is working at the freight yard when his friend Mischa begins to consider stealing potatoes from a freight car. To stop Mischa from committing this theft, Jacob tells him about the Russian advance, but Jacob also lies about having a banned radio to make his information seem more credible. The news that Jacob has a radio spreads throughout the ghetto, and he decides to build on the lie by claiming the Russians are getting closer and closer to the ghetto. Jews throughout the ghetto begin to feel hope due to Jacob's lies; suicides, which were previously common amongst the ghetto's inhabitants, all but disappear.
Yet, as time goes on and nothing changes for the better, the Jews begin to feel discontented. Jacob continues to lie even while the situation within the ghetto seems to be deteriorating. People are killed and deported by the Nazi officers administering the ghetto. A worker at the freight yard named Herschel Schtamm, for example, is killed for approaching a boxcar that is transporting people. Dr. Kirschbaum, who is called upon to treat the head Nazi officer's heart attack, commits suicide. So does Kowalski, Jacob's friend, after Jacob cracks and confesses that the radio is fictitious. The parents of Mischa's girlfriend, Rosa, are sent to death camps during a period of widespread deportations.
Throughout the text, Jacob takes care of and interacts with an eight-year-old girl named Lina, whose parents were deported two years prior to the events of the narrative. Soon after Jacob begins lying, Lina learns of his fictitious radio and becomes desperate to see it. Jacob instead stands behind a partition and mimics a radio, "playing," among other selections, a telling of a fairy tale. In this fairy tale, which becomes enormously important to Lina, a princess grows sick and says she can only be healed if she is given a cloud. A garden worker talks to the princess about her illness, and the princess tells the worker that clouds are made of cotton and are as big as pillows. He heals her by giving her a large piece of cotton, and the two are married.
The novel's narrator provides the reader with two different endings for Jacob's story. In the first ending, which is fictitious, Jacob never confesses that his radio is fake, so Kowalski never commits suicide. Yet, Jacob is killed for attempting to escape the ghetto on the day before the Russians arrive. The Red Army liberates the Jews in the ghetto. In the second ending, which is true, Kowalski remains dead, and all the remaining Jews in the ghetto are deported to extermination camps.
