People with loudness recruitment have a compressed dynamic range between the sound-pressure levels corresponding to threshold and discomfort. This highly frequency-dependent phenomenon requires a nonlinear filter for compensation. To achieve the high levels of gain required for profound hearing impairment, the hearing aid must also be capable of canceling the ever present acoustic feedback. This paper describes a digital hearing aid, realized in the frequency domain, that compensates for recruitment of loudness and cancels echos. The DFT-based approach permits the use of fast and computationally efficient algorithms for the nonlinear compensation and adaptive FIR filtering. The echo canceler is adapted using only the available (e.g. speech) input signal. An analysis is presented of the closed-loop hearing aid system and the adaptive adjustment law. The problems resulting from the use of a nonlinear hearing-loss compensator and stability problems caused by a rapidly changing echo path are discussed. The proposed solutions have been implemented and tested on a dummy head using a behind-the-ear hearing-aid device. The result is a device that runs more than 20 dB above the critical gain without any audible artifacts.