While the term had no racial ('Nordic') or linguistic ('Indo-European') meaning, it did originally have an ethnic meaning. On this, invasionist linguist JP Mallory and anti-invasionist historian Shrikant Talageri agree. At least, it has a relative ethnic meaning, not designating a particular nation, but being used by several Indo-European nations (viz. Anatolians, Iranians and Paurava Indians) in the sense of 'compatriot', 'one of us'. This term, in India, then evolved to 'one who shares the civilizational norms of the Vedic Paurava tribes', 'Veda-abiding', 'civilized'. And thence 'noble'.
The use of Arya cognates in Hittite and Lycian (Anatolian) in the sense of “compatriot, fellow citizen” is given in standard textbooks of Indo-European linguistics, such as JP Mallory’s, and in the On-line Etymological Dictionary http://www.etymonline.com/
The same in Iranian is beyond dispute. Iran itself is from Airyanam Khshathra. In 2006, Tajikistan hosted the UNESCO-sponsored World Aryan Fair, where “Aryan” in effect meant “Iranian”, including Baluch, Kurd, Osset (Scythian), Pathan and Tajik. Non-Iranians including Indians were Anairya to them, regardless of whether they called themselves Arya.
The evidence for Arya used in the Rg-Veda in the sense of “compatriot” is given at length in Talageri’s latest two books, The Rg-Veda, a Historical Analysis and The Rg-Veda and the Avesta, the Final Evidence. He arrived at his conclusions without any knowledge of the linguists’ findings. What he shows is that the Paurava tribe, in which (particularly, in whose Bharata clan) the Veda hymns were composed, referred to its own members as Arya. All others, including Iranians (“Dasa”, “Dasyu”, “Pani”) and non-Paurava Indians (Yadava, Aikshvaku et al.), were counted as Anarya.
Contrary to Arya Samaji and other modern-moralistic interpretations, Arya does not mean “good” nor Anarya “bad”: even a hostile reference to a traitorous fellow-Paurava calls him Arya, even non-Paurava friends whose virtues are praised remain Anarya. It is only when Paurava Vedic tradition become normative for the neighbouring tribes that Arya gradually loses its Paurava exclusiveness and acquires the non-ethnic meaning of “Vedic”, “partaking of Vedic tradition”, “civilized”, “noble”; and “Anarya” becomes “barbarian”.
One resultant semantic development is 'upper-caste', meaning those people who received the Vedic initiation. Since Kshatriyas and Brahmins had their own more specific titulature, the general honorific Arya often designated the Vaishya. It is also used as a form of address to any honoured person, which is probably the origin of the present-day honorific suffix -ji, evolved through the Prakrit forms ayya, ajja, 'jje. In South India, the term Arya designated the Northern immigarnts who described themselves as such: Buddhist and Jaina preachers and Brahmin settlers. They latter's caste names Aiyar and Aiyangar are evolutes of Arya.
It is in the sense of 'noble' that the Buddha spoke of the Arya 4 truths and 8-fold path. However, we must take into account the possibility that he used it in the implied sense of “Vedic”, broadly conceived. That after Vedic tradition got carried away into what he deemed non-essentials, he intended to restore what he conceived as the original Vedic spirit. After all, the anti-Vedicism and anti-Brahmanism now routinely attributed to him, are largely in the eye of the modern beholder. Though later Brahmin-born Buddhist thinkers polemicized against Brahmin institutions and the idolizing of the Veda, the Buddha himself didn’t mind attributing to the gods Indra and Brahma his recognition as the Buddha and his mission to teach; and when predicting the future Buddha Maitreya, had him born in a Brahmin family; and had over 40% Brahmins among his ordained disciples.
I haven’t looked into original sources about this yet, but surmise that pre-war racists waxed enthusiastic about descriptions by contemporaries of the Buddha as tall and light-skinned. That would be “Aryan” in the then-common sense of “Nordic”. Nowadays, some scholars including Michael Witzel suggest that the Buddha’s Shakya tribe may have been of Iranian origin (from Shaka, “Scythian”), which would explain their fierce endogamy. They practised cousin marriage, e.g. th Buddha himself had only four great-grandparents because his paternal grandfather was the brother of his maternal grandmother while his maternal grandfather was the brother of his paternal grandmother. The Brahminical lawbooks prohibited this close endogamy (gotras are exogamous) and like the Catholic Church, imposed respect for 'prohibited degrees of consanguinity'; but it was common among Iranians. (It was also common among Dravidians, a lead not yet fully exploited by neo-Buuddhists claiming the Buddha as “pre-Aryan”.) The Shakya-s justified it through pride in their direct pure descent from Arya patriarch Manu Vaivasvata, but this could be an explanation adapted to the Indian milieu hiding their Iranian origin (which they themselves too could have forgotten), still visible in their physical profile. Thus far the “Iranian Buddha” theory.
It is possible and indeed likely that other Indian tribes contemporaneous with the Vedic Paurava-s also called themselves Arya (and the Paurava-s Anarya), but they have left us no texts to prove it. Such usage may have facilitated the adoption of the term Arya in the (to them) new meaning of “Vedic”.
The 19th-century claims of the use of an “Arya” cognate as ethnic self-designation in Celtic (“Eire”) and Germanic have been abandoned, as well as the relation with German Ehre, “honour” (which is from *aiz-, cognate with Latin aes-timare, whence English esteem). There is no firm indication that it ever was a pan-Indo-European or Proto-Indo-European self-designation and thus a valid synonym for “Indo-European”.
