Your question raises a big debate in psychology circles these days. While some people believe that praise can have positive effects on a child's self-esteem, others suggest that praise can have unexpected negative results. My advice lies somewhere in between.
There is no question that all children want and need praise. Children like knowing that their parents approve of who they are and what they do. But when a child begins to depend on praise for her total self-esteem, then praise can become a real problem. You can recognize this in your child if he starts asking "Is this good?" all the time or looks to you for approval for everything he does.
What kind of praise works best? Certainly not comments like "terrific," "wonderful," or "you are the best!". These are like empty calories -- they are easy to grab and instantly gratifying but don't provide real nourishment to a child's self-esteem. Instead you should try to describe your child's behavior or your feeling about a behavior, e.g., "I noticed that you cleaned up your room," or "I really appreciated the feeling you put in your composition." This type of feedback suggests concrete reasons for a child to feel genuinely competent and good about himself. Another good way to raise your child's self-esteem is to ask him reflective questions about his ideas or projects rather than comment on them. Questions like "What parts of that did you enjoy the most?" or (asked in a non-threatening way) "Why did you decide to do it that way?" indicate your attention and interest much more than praise.
I have two favorite books that deal with the issue of praise. One is How to Talk So Kids Will Listen and Listen So Kids Will Talk by Faber and Mazlish; the other is The Skills of Encouragement by Dinkmeyer and Losoncy. Both provide practical suggestions and models for effective praise and encouragement. Hope this helps!