Proposals to build a “Titan” jail in Maghull, near Ashworth High Security Hospital, were first put forward by Labour Home Secretary John Reid in 2007.
MoJ officials said they had informed Serco, the preferred bidder for the £400m contract to build and run the prison, that the scheme had been axed.
The decision is a blow to Skanska, which was in line to build Maghull for Serco.
A spokesman said: “Following the Comprehensive Spending Review and the publication of last week’s consultation Green Paper on sentencing and rehabilitation, we will now look in detail at the sentencing frameworks for adults and young offenders, and the full range of penalties currently available to sentencers.
“We will also look to overhaul the system of rehabilitation to reduce reoffending.
“Long-term decisions on prison capacity programmes will be taken in the light of future policy developments and a projected fall in the number of offenders in custody,” said the spokesman.
Last week, Justice Secretary Ken Clarke pledged to break the cycle of crime by tackling the root causes of reoffending.
His Green Paper on sentencing aims to cut the 85,000 inmate population by 3,000 by reducing reoffending without reducing the punishment of offenders.