WASHINGTON - U.S. Treasury Secretary Timothy Geithner Wednesday warned that should the headwinds from oil prices, Iran or the Eurozone crisis cause a slowdown in the recovery, U.S. economic activity will not expand at the rate needed to make substantial dents in the unemployment rate.

Right now, however, "the U.S. economy is gradually healing, gradually getting stronger," Geithner said during a moderated discussion at the Brookings Institution, adding that although there are a lot of headwinds -- such as the crisis in Europe and high oil prices -- "we are making quite a bit of progress."

In its World Economic Outlook Tuesday, the International Monetary Fund revised up U.S. growth by 0.3 to 2.1% in 2012 and by 0.2 to 2.4% next year.

Geithner said growth would need to be at a rate far above 2.25% to 2.5% for the unemployment rate to decline at a more significant pace.

If oil prices, Iran tensions, or Europe's struggles conspire to slow the momentum of the U.S. economic recovery, then U.S. growth "will be at the weak end of that range," Geithner predicted.

However, "we are in a much stronger position to deal with even those challenges than we were even six months or a year ago. Most things you can look at and measure in the U.S. economy today suggest more resilience," he added.

Geithner described economic strength in the U.S. as "pretty broad-based," from agriculture, energy, high-tech, to the manufacturing sector.

And the continued weakness in the construction and housing sectors is understandable and necessary, Geithner said.

Geithner said the economy is making a broad adjustment towards becoming more export and investment-led, with an improvement in the private savings rate -- and the beginnings of improvement in public savings -- and the financial sector is "much more stable."

In addition, the world is in the early stage of what Geithner said will be "a very long period of pretty substantial rates of growth in the emerging world ... and we are better positioned than most developed economies to take advantage of that."

Still, there are some risks and uncertainties ahead, the Treasury Secretary said, citing the "very long, protracted, difficult" challenges ahead for Europe.

He added that although oil prices to-date have not had a materially significant and negative effect on overall growth so far, "there is still a lot of uncertainty around oil markets." 

And looking forward to the end of the year, the U.S. is faced with the expiration of a substantial number of tax cuts.

"The potential impact of a large automatic cut in spending, another debt limit debate ... will be a big test of Washington, big test of the capacity of this country to govern itself," Geithner said.

Tax reform is coming, it is "inevitable" and necessary, Geithner said, with the only question being what form it will take.

Geithner said there are three things lawmakers could do that would provide some reassurance to financial markets.

"One is that Congress will pass the debt limit without all the drama and politics and damage," he said.

The second is to recognize that the tax proposals currently being debated would affect 2% of taxpayers and would involve only a modest increase in the effective tax rate of those Americans. So only a "very small fraction" of the American economy would be affected.

The third is that restoring fiscal sustainability must be done in a manner that is "calibrated to the strength of growth and recovery," Geithner said.

"If you cut too quickly, if you try to bring about too precipitous a withdrawal of fiscal stimulus then the risk is that you do damage to the recovery and you undermine the objective you are trying to move forward," he added.

If Capitol Hill can show a commitment to the above three tenets, Geithner said that would help reduce some of the uncertainty surrounding the end of the year.

Market News International is a real-time global news service for fixed-income and foreign exchange market professionals. See www.marketnews.com.

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