If the picture you're putting in is low res to begin with, there's no way the iPod can up-convert it so it looks better... If the picture is higher res than the screen, it should look fine (though the iPod does scale it down for displaying it, turns any size pic into like a 660KB file IIRC, and it saves a thumbnail sized pic as well to speed up navigation).
If you're talking about pics saved off e-mails and stuff, then that's a bug... Right now the 2g seems to save pics off e-mail properly, but when you look at them on the iPod they look blurry as hell... However it's saved properly because when you sync to the PC they look fine there. My guess is it's flagging them erroneously and opening the thumbnail instead of the 660KB file when you open it.
If you open them in Scribbler they look fine too (though that app does funny stuff with certain size/orientation pics). Other apps open the same blurry mess though, dunno why... Guess the apps have several ways to access the pics and some do it the same way the iPod's photo navigation app does, while others don't.