This information was provided by Claris Corporation on 16 March 1998, and incorporated into Apple Computer's Tech Info Library.
Turning Fractional Character Widths on tells the Macintosh to space characters more finely when printed. This makes low-resolution fonts look bad, because they're not designed to be spaced this closely, but it vastly improves the look of high-resolution fonts when printed to a high-resolution printer.
Generally, if you're designing something to be displayed on screen, or for a low-resolution printer, it's best to choose low-resolution, or "city-named" fonts, and leave Fractional Character Widths off. But if you're printing to a laser or inkjet printer, and an occasional compressed character on screen doesn't bother you, then you should use high-resolution fonts and have Fractional Character Widths on. That's the setting most people should and do use. Note that none of this has anything to do with whether or not the font you're using is a TrueType or a bitmap font. TrueType fonts scale to any size very nicely. Geneva, New York or Monaco are not going to be spaced (kerned) as well as a high-resolution font when printed to a high-resolution printer.