The problem with many polyurethane varnishes is that successive coats don't melt into the previous ones the way other top coats like lacquer and shellac do. Once dry, the solvents in the next coat don't activate the existing poly. Sanding is required to scratch the surface and add tooth for the following applications. You don't want to use a fine abrasive like steel wool because the scratches aren't deep enough to make the bond. In worst cases, you can have a coat of poly lift off the previous one, each application can act independently like a separate skin.
When leveling and polishing out a finish, steel wool is a good choice but it's better to start with fine sandpaper. The sandpaper will cut off dust nibs, runs, solvent craters or other imperfections quickly. Doing that with steel wool means you will work the surrounding area, removing a lot of the top coat build just to get the offense out. The time to use steel wool is after those nibs are removed. It will lightly blend in sanding scratches and minor areas that aren't level. Other than Liberon steel wool, standard steel wool contains oil. Using ordinary steel wool can leave oil on the surface and further prevent successive coats from bonding.
Another issue with steel wool between coats is that it can leave minute bits of the steel in open grain and joints. The steel bits can oxidize over time and effect the adhesion of the top coats. Boat builders don't use steel wool, they either use bronze wool or synthetic because of this. That's not as big a problem after the top coats are completed but in between coats it will lock in the steel bits.
You can get a very attractive finish by cutting off nibs with the finest paper that will work, follow with steel wool or a synthetic, then apply furniture paste wax and buff. That's all you need for most items. For a dining room table or other item where you want a perfect finish, using a polishing compound after the steel wool will take it to the next level. A perfectly flat and polished top coat doesn't break up light reflection, it acts like a lens over your wood. You should be able to see single hairs in your reflection that are straight and clear, not wrinkled or broken. Be warned, the finer the top coat polish, the more any minor imperfection will show. When going this route, you need to build enough surface film so the various abrading steps don't go through, especially on edges and proud areas. Sanding can't be a back and forth motion like you do on raw wood. If one stroke will cut the nibs and level, that's all you want to do. That should be all you need between coats, too. Use 220 or coarser to keep the scratches for adhesion.