it's been a while since I've set up a G3 machine with a new drive - in fact I just took my old faithful PowerMac G3/266 beige tower out of service... but I recall to install Mac OS X you need to partition the drives so the boot volume is no larger than 8GB, that's what I had set up on that G3. perhaps that's your problem.
I found [http://lowendmac.com/imacs/rev-c-imac-g3-266-mhz.html|an article] about the iMac G3/266 and it seems to say the same