Many conventional video coding schemes, such as the CCITT H.261 recommendation, are based on the independent processing of nonoverlapping image blocks. An important disadvantage with this approach is that blocking artifacts may be visible in the decoded frames. We propose a coding scheme based entirely on the processing of overlapping, windowed data blocks, thus eliminating blocking eftects. Motion estimation and, in part, compensation are performed in the frequency domain using a complex lapped transform (CLT), which can be viewed as a complex extension of the lapped orthogonal transform (LOT). The motion compensation algorithm is equivalent to overlapped compensation in the spatial domain, but also allows image interpolation for subpixel displacements and sophisticated loop filters to be conveniently applied in the frequency domain. For inter- and intraframe coding, we define the modified fast lapped transform (MFLT). This is a modified form of the LOT that entirely eliminates blocking artifacts in the reconstructed data. The transform is applied in a hierarchical structure, and performs better than the discrete cosine transform (DCT) for both coding modes. The proposed coder is compared with the H.261 scheme and is found to have significantly improved performance.