I would go over the top window.

above!

caminnc..... Did you mean the transom??

Yes, sorry!

That upper window is very cool, I say leave it alone.

Hanging above the transom makes the window appear taller and to me, that is always the goal. I would also apply trim molding to the window and transom.

lol, looking at my own pic made realize its not just the window that bugs me, its the whole front area. We just bought this house (it was a forclosure) and this is the only area that I'm stumped on, so I'm gonna take another pic., repost, then address a few problem areas
.... stay tuned

Your requirement is to make your room stylish and according to my opinion over the top will be great for your room. Best of luck for your decoration..

Definitely above the transom.

How far up does the wall go?

And how attached are you to the vertical blinds? I don't think they do anything good for those nice, deep-set window openings.