Trying the blink example code without any modification on a Duemilanove board (with ATMEGA328) I get the board LED blinking correctly every 1000ms and the LED connected to pin13 blinking almost three times during the on cycle of the board led...
It might be a flashing LED - some LEDs have a chip inside them that makes them flash. Does it flash when connected to +5v? (use a series resistor for this test - even though if it is a flashing LED it probably won't need one)