Honestly, WinMe worked beautifully for me back in the day. I have no complains about it. And I never even updated it! Guess I was lucky.
That being said, and considering the specs of that PC, I'd drop Windows XP in there. 512 MB is big enough, and that processor is gonna do just fine. My mom has a Pentium III 800 Mhz with 512 MB of RAM and Windows XP, and she does her office, browsing and music stuff in there. No complains, and that's with a much slower CPU than you.
Don't bother with Win ME or Win 98.
EDIT: Hadn't seen you already installed Win XP. Well done.