This is why you should test any final DVD projects on a TV screen, because despite how good your video looks on the computer, interlacing artifacts can seemingly be created out of thin air. (Which leads me to wonder - are you seeing these artifacts in Vegas, or are they suddenly appearing when you watch the video on TV? You said this was a recent change, so perhaps this is the cause?)
Interpolating simply refers to creating new frames/pixels/visual information in between existing frames/pixels/visual information. It can be used to create new scan lines in each frame, thus turning interlaced video into progressive video. (Speaking of which, you might want to look under PROJECT PROPERTIES for DEINTERLACE METHOD. Try setting that to "None" and see if it helps. Deinterlacing can actually make video look worse under many conditions.)
It can also be used to create new frames between frames, thus creating the impression of "slowing down" video. If you looked at the samples on the MotionPerfect website I mentioned, you will see some FANTASTIC examples of frame interpolation. This software is amazing!
BTW, if you really love this software, I highly recommend this book. It is my bible now. (There's an updated version for Vegas 6. I've not read this one, so I don't know what the differences are.) The book comes with a DVD full of project files, moving backgrounds, ACID audio loops, and all sorts of cool stuff.
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