Yeah, too soft.

I searched the Web for "newborn photography photoshop" and got thousands of returns, some of which are tutorials.  Some of those sites have specialized actions for sale for smoothing the skin, getting rid of the red, etc., but be aware -- not all Photoshop actions will work in PSE.  If you decide to purchase an action, make sure it's compatible with your version of PSE, and get a money-back guarrantee.

In general, to keep an area sharp while softening the rest of the image you need to duplicate the image layer, soften that duplicate layer and use a layer mask on that softened layer to reveal the sharp image beneath it wherever you paint on that layer mask.  It's easy to add a layer mask in PSE10, but a little more complicated in PSE7 (which I've never used), so someone who has PSE7 will have to jump in here on that....

Ken

OK, I figured out how to get a layer mask for your blurring using the features available in PSE7 -- it's called "hijacking" a layer's mask:

1. Add a Levels adjustment layer.  Leave the levels adjustment settings as is to just use this levels layer for the blur effect.
   
2. Make a duplicate copy of the background layer and move the duplicate copy above the Levels adjustment layer.
3. With that duplicate layer highlighted, apply as much blur as you want.
4. With the blurred duplicate layer still highlighted, use Layer...Create Clipping Mask.
5. In the Layers Palette, click on the mask image of the levels adjustment layer to activate the mask.
6. Paint with black to reveal the sharp background image.

Your layers will look like this:

And the final image:

Ken

Here is a free download:

http://www.autofx.com/freeplugins/dreamyphoto.asp?id=4

Try Camera raw:

Flie>open as and specify camera raw

The luminance, clarity, and tint sliders work well on this photo.

I had it on my old computer (WIN-XP), and have it now on my new computer (WIN-7).

I elected to download the free-standing version. Seems to be safe.