Thesis reviewer requests update to literature review to incorporate last four years of research. Do I need to do this?

The criticism is that you're not up to date on the current state of your own field of specialty, and it is not a light matter. If the "reviewer" is some sort of committee member that can throw a wrench into your exit process, you should address the criticism.

The real issue is how to address it. My assumption here is that your defense will be "typical", with a formal presentation followed by some sort of closed session.

You have a very limited amount of time before your defense, and you need to use it wisely. To start, I'd pick the five most relevant citations to your work that you have, and search them forward to see who cited them, and read those papers-- there will probably be less than 20. If nothing earth-shattering has happened, you will eventually add those to your reference list, and all should be good. If there is something earth shattering and pertinent to your work, you probably have more research to do at this point.

How will your reviewer know you did it? Well, for the closed session, you should have a slide in your rack entitled "review of recent literature". In closed session, make the opportunity to say "in review, a criticism of how up to date my knowledge of the field was came up. This was accurate, and this is how I've responded... I think I've covered this, and will continue to stay up to date with the literature".

To add, they may require a bit of a rewrite-- that's actually fairly common-- but worry about that when the time comes. The strategy is to to convince them that you've done the work, and you're ready to do that rewrite. You don't have the time to do it between now and your defense, and my experience is that the document is largely sealed until it's defended anyway. You're trying to set things up so your revised dissertation will be signed off on without a thorough going-through.

First, if a reviewer stated that you should better do something, then you better do something (in most cases, do what the reviewer says, unless you have a very good reason to do something else).

Second, the reviewer is right here. You have to keep up to date with the literature, and provide a literature review in your thesis which is up to date at the time of submission. Four years is a pretty long time for fast-moving fields, and even for slower-moving fields it is still not negligible. On the other hand, refreshing a literature review for four years of new research is a doable task.

If it really is the case that you did not keep up with the literature in the past four years, it may be that you missed some important developments. Many things may have happened and I can't answer the question "what now?" without knowing more details.

While writing a lierature review early is a good idea, it's a mistake to regard this as the literature review. The early literature review is better though of as something for your own use (plus your supervisor and any internal requirements).

It's quite possible that you've kept up with the literature but not demonstrated that in the thesis -- which is essentially the same as not putting the thesis in context.

From where you are now, it seems like you really should update (not rewrite) it. If you have kept up this shouldn't be too hard. Even if you haven't you could be lucky and find a good recent review paper that you can use as an index to developments with some context and weighting. Even if you're unlucky and there isn't such a paper, looking for it is helpful to writing your review. Check for recent/relevant publications from anyone involved in your defense.

Actually getting stuck in to recent literature on your subject is a good way to prepare; although the writing side of it is a chore, you're not in such a bad position as you seem to fear.