The camera software makes the image larger by guessing the bits between the actual recorded information. If you need to do this your computer is more powerful and does it better
It can be useful but it's best to ignore this when comparing cameras, likewise with digital zoom
Say if a digital camera takes a picture of say 3.1 million pixels, the interpolation is when you take the picture in a different pixel amount say 5.1 million pixels.
The camera has then to fill 2 million pixels with more pixels. An interpolated digital camera adds pixels to the picture, a good interpolated camera can be good, but if its bad... all your pictures will have lots of white dots on them :)