Can't downgrade or update jailbroken iPhone
The host file is not the original. That 

74.208.10.249 gs.apple.com


resolves gs.apple.com to 74.208.10.249 (nginx.saurik.com) and not the real server by Apple, so that the SHSH trick works. Probably you have added it at some point. If you remove that you should be able to upgrade to iOS 5.1 using Apple's update. However, depending on the bootrom that you phone has, you may or may not be able to do a untethered jailbreak with Redsn0w, so be very careful before deciding whether you want to upgrade (although you say you have tethered jailbreak so probably you can live with tethered).

As for downgrading, I am not sure why you can't do this, chances are that you don't have SHSH for lower versions in Cydia.

Edit: for downgrading you may have to use another IP address in the hosts file. I've seen 74.208.105.171 used recently (check the recent tutorials for saving SHSH blobs, the IP address may have changed)